The company you work for has been growing very slowly and has decided to increas
ID: 2808848 • Letter: T
Question
The company you work for has been growing very slowly and has decided to increase its growth by acquiring another company. You are in charge of negotiating the deal.
The target business (seller) has EBITDA of $3 million and the price is $25 million which you believe is too high. The seller says their price is based on the future potential of the business which after all, is what buyers buy - future cash flows!Your bank will only lend $18 million.
Present your argument to the seller (who will be role-played by the professor) on how to negotiate this acquisition.
Explanation / Answer
•The price which you(the seller) has been asking results in Price/EBITDA multiple of 8.33 times(25/3) which is a bit too higher than that paid in our industry, keeping in mind the recent acquisitions in the past.
• I take your point that you are basing the price on future potential and better cash flows. However, the higher future cash flow is a forecast which you have made based on expectations regarding:
growth rate of the industry
competetiveness in the industry
the company's market share and pricing power
company's strategy, bargaining power of buyers and suppliers.
level of technological advancement.
state of economy, government policies etc.
All the above factors however are not constant and they may change very differently as compared to your expectations. Lets for example say that you predicted a growth rate of 12% for the industry and there is a recession or government policies work against the industry, then suppose the realised growth may only be 6% and so valuations will fall drastically.
My main purpose is to convey that forecasts are never fully accurate. Instead they are based on expectations of the person who may be either optimistic or pessimistic.
Our team have done the requisite reasearch and based on the expectations and valuation arrived at, our company feels that your valuation assumes numbers which are highly optimistic. Our company will offer you $ 18 million for the acquisition which factors in a reasonable growth rate and other factors. It will result in a Price/EBITDA ratio of 6 times(18/3) which is pretty good considering the present state of the and its future potential. Also, we will offer upfront settlement in cash and will also take over your debts.
Students, please give a feedback. Thank you.