How to Bridge a Valuation Gap

A valuation gap is a common occurrence in M&A. The seller may have a biased view of their business, and therefore value it higher than what the business appraiser actually deems its valuation number. Or, the buyer may be fixated on a business's flaws (or be strapped for cash), and may not want to pay the full business value. There are a number of ways to work together to bridge this valuation gap that do not involve having to walk away from a deal.

Seller Financing
Seller financing is one of the most common tactics for making a compromise to close the gap. Typically, this comes in the form of an earn-out. An earn-out is structured so that the buyer pays for the business up front, but then also gives the seller the opportunity to earn more capital as long as certain stipulations are met after the business sale. Seller financing allows the seller to "put their money where their mouth is", as a sort of concrete display of their confidence in their valuation of the business. It also allows the buyer to only pay the full asking price if the business does indeed live up to expectations.
If not an earn-out, then the seller can instead provide a note that includes a high interest rate, so that they earn more over time in return for providing a portion of the financing.

Rolled Equity
If the stock in the business is valuable and the seller believes that they can sell it, then this may be a good option for helping bridge valuation gap. Depending on the amount of stock paid to the seller, this may mean that they maintain control over a portion of the business even after the sale. It is within the buyer's best interest to only sell a minority stake (less than 50%), in order to maintain greater control of the business after purchase. Rolled equity is a good option to help avoid tax consequences on the portion of the equity being sold.

Re-Valuation
Perhaps the original valuation was only a basic valuation that did not take into consideration the gravity of various aspects of the company. Or, perhaps the seller attempted to evaluate their company on their own terms, and needed professional assistance. If the valuation number was not presented by a professional business valuator through extensive research, then it may not be illustrating the true worth of the company. Be sure to have it appraised by an M&A professional for the best results.

If you would like to have your company appraised, or would like to know more about financing options for buying or selling a business, please contact us confidentially at George & Company. We are one of the leading firms in the area that assists with appraisals, buying, and selling of middle market businesses.