Company Acquisition: Purchase Price and Pricing Strategies
The determination of the purchase price to be paid at the closing of the transaction, also known as the equity value (“EQ”), is of great significance in terms of the pricing mechanism agreed upon by the seller and the buyer, and how much flexibility the buyer allows the seller.
Fundamentally, two main pricing mechanisms are distinguished: in one, the method of determining the company’s value (but not the purchase price) is fixed in advance, while in the other, the cornerstones deemed fixed based on the company’s financial statements are defined, and the price (purchase price) is built on this basis.
1. The method of company valuation is the fixed element
According to the first method, the parties agree on the methodology used to calculate the company’s value, on the adjustment items, and on their expected value and/or valuation mechanism.
In this case, no fixed enterprise value is defined (“EV”): the multiplier used for the calculation and thereby the equity value (“EQ”) are also flexible.
Items that need to be agreed upon in such a setup may include, for example, the value of the net debt or the difference between the average and current net working capital (“NWC”).
Advantages: more flexible, it adapts to uncertainties present at the time of signing the Sale and Purchase Agreement
Disadvantages: it may result in significant adjustments or value modifications afterwards. Any change in the purchase price compared to the planned amount may also have a psychologically adverse impact on the seller.
2. The financial data serve as the fixed starting point of pricing
In this case, the valuation of the company and the closing of the transaction are carried out based on known, fixed values derived from the financial statements.
With a pricing strategy based on financial data, we cannot speak of a wide valuation range, and no subsequent adjustments take place. The buyer and the seller jointly assign values to specific items and decide together on the final, fixed Purchase Price based on the most recent financial statements.
A thorough financial, tax, and legal due diligence is of key importance to identify potential risk areas and rank them based on their significance. As a result of the financial due diligence, the target company’s weaknesses and any hidden liabilities may be uncovered, and the associated risks can be quantified.
Advantages: faster and more predictable transaction
Disadvantages: less flexible, no opportunity for later price adjustments
It is advisable to consider applying the method based on fixed financial data in cases where:
- The timing of the transaction closing significantly influences the equity value.
- The business operation is time-limited (e.g. concessions, fixed-term contracts).
- The target company has already undergone several audit adjustments.
- A major investment is expected in the near future.
- There has been no recent audit, or the reliability of the latest audit is questionable.
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The Impact of Emotions and Intuition on the Transaction
Transactions are not solely based on rational financial and strategic decisions—they are also significantly influenced by emotions, intuition, and cognitive biases.
The Role of Intuition
Executives often rely on their experience and instincts when evaluating the acquisition of a company.
Intuition can be especially important in the following areas:
- Cultural fit: The compatibility of the two companies’ organizational cultures often depends on non-quantifiable factors.
- Leadership dynamics: During negotiations between sellers and buyers, the trust and chemistry between executives can be decisive.
- Perception of market position: Recognizing industry shifts or competitive advantages often stems from business intuition.
Cognitive Biases That Can Influence Decision-Making
Even the most experienced business decision-makers are prone to psychological errors that may lead to poor investment decisions.
- Overconfidence bias: Decision-makers tend to overestimate their own abilities (and their own company’s financial position) and underestimate the risks of the acquisition.
- Status quo bias: Owners / executives may find it difficult to deviate from their usual way of operating, making them hesitant to take necessary steps.
- “Pink” (anchoring) bias: Initial offers or information presented during the first price negotiations can disproportionately influence later decisions.
- Endowment bias: Sellers are often emotionally attached to their company, leading them to expect irrationally high prices. Buyers must therefore be especially cautious in how they present what they believe to be the company’s actual value to the seller.
Emotional Factors in Selling a Business
Selling a business is not just a transaction—it is also an emotional journey.
Sellers often struggle with the following dilemmas:
- Sense of loss: Sellers may experience a form of identity loss, especially if they spent many years building the business, and buyers should be mindful of this transitional phase.
- Uncertainty and fear: Employees and executives of the acquired company often worry about integration, downsizing, and new leadership structures. These concerns should be addressed by the parties during the transaction itself.
- Decision-making difficulties: Emotions can distort rational price setting.
How to Reduce Psychological Biases?
- Involving external advisors – An independent expert sees the situation objectively.
- Data- and fact-based decision-making – Leaves less room for emotion-driven decisions.
- Scenario analysis – Reviewing multiple scenarios reduces the risk of falling into the trap of excessive optimism or pessimism.
ACQUISITION - I HAVE A QUESTION ON PRICING
Taking psychological factors into account and consciously addressing them can significantly increase the success rate of a company acquisition and reduce the risk of potential failure.
A successful acquisition is not just about the numbers—it also involves the emotional attitude and psychological mindset of the parties involved. Choosing the right pricing method and consciously managing psychological factors can help avoid pitfalls and ensure a successful transaction.
