In the world of M&A, few issues are as vexing as valuation. M&A professionals know all too well that one of the most common sticking points in negotiation is valuation. In order to learn about the hurdles M&A practitioners face when determining a valuation, Firmex, in partnership with MergerMarket, conducted a survey of senior executives at North American investment banks, private equity firms, and corporations.
In M&A Valuation: Trends, Challenges and Horror Stories, these executives share their views on the challenges they face in negotiating the value of an asset, the most common blunders they see made – and a few of the horror stories they have gone through in assessing company valuations.
Even as dealmakers gain access to better analytical technologies and refine due diligence procedures, evaluating the value of an asset with precision can still face a number of obstacles. For M&A dealmakers, this means overcoming existing mental biases, appraising the worth of an asset’s intangible qualities, and everything in between.
Key findings in the report include:
- A majority of those surveyed indicate that it was either “much more difficult” (12%) or “somewhat more difficult” (60%) to arrive at a valuation in a strategic deal rather than in a strictly financial deal.
- Dealmakers say three common biases play a role in valuation judgment: the bandwagon effect in a hot sector (68%), relying on a precedent set by a similar company, referred to as anchoring (72%), and ignoring the intangibles of a target in favor of financials (72%).
- Unanimously, all survey respondents say they judge whether the valuation of an acquisition was justified after four years or less, with 52% indicating a timeframe of three to four years.
Valuation – Art or Science?
While once thought of as an art form, dealmakers revealed that the valuation process itself is slightly more science than art in today’s modern M&A market. This shift can be attributed to the rise of new technologies and better due diligence helping to improve asset analysis, as explained by a senior M&A director at a cloud computing company, who states: “Data analytics and machine learning coupled with AI are changing the way information is retrieved and analyzed. Highly precise and accurate data can be sourced, which helps us arrive at a proper valuation in an M&A deal.”
However, even as dealmakers have access to more precise data, some valuation gaps are still difficult to bridge. At least a third of those surveyed said the situation comes down to a difference in opinion regarding the target’s potential growth. Another reason may be due to the difficulty in evaluating tangible assets. A managing director at a US-based PE firm explains:
“This phenomenon is most common in healthcare, manufacturing, and energy sector deals, as the valuing of the company’s assets is a tedious task. More than the brand value, the valuation of the physical and intellectual assets of the company affects the valuations greatly.”
Another complicating factor revealed by dealmakers relates to existing mental biases that can impact a target’s valuation. The most dangerous of these biases according to survey participants is ignoring the intangibles in a deal. “Financials are important,” the managing director at a mid-market firm explains, “but other important factors such as product or service mix, competition, and operation details get ignored, and they often make a bigger impact on the actual numbers.”
The research report indicates that the top intangible aspect dealmakers look at during valuation is the quality and fit of a target’s management team. This is echoed best from the director of M&A at a technology company, who states: “We attach a lot of value to the human intellect in the organization, since if that aspect is present, the deal will pay great dividends.”