synergy-price-240px-577336728When selling a business, did you know there are some buyers who would be willing to pay a premium above the fair market value of the business on a controlling basis? These are strategic (or synergistic) buyers, and might include competitors looking to build market share, joint venture partners who already understand the business model or players that are vertically integrated along the supply chain. This premium typically is the result of cost-saving or revenue-building synergies that exist between the buying entity and the selling entity.

For example, let’s assume that Company A manufactures an apparatus that connects to an anesthesia tank on one end and the patient’s facemask on the other end. Company B manufactures the facemask device that connects to the Company A apparatus. Company B wishes to acquire Company A. With the ability to cross-sell both devices and reduce costs, the companies will experience higher profitability than either could attain by remaining separate. That’s called synergy.

When defining synergy, people often quote Aristotle; “the whole is greater than the sum of its parts.” Generally in the sale of a business, when synergies exist the value is negotiated between the buyer and seller, rather than one party getting the full benefit. In valuation terms, it requires investor-specific assumptions to arrive at “strategic value,” as opposed to “fair market value,” which is the price the universe of potential buyers and sellers would agree to. Collaboration is required for maximizing strategic value between the buyer and seller. Often the seller helps transition the business post-sale through ongoing employment or consulting contracts.

Putting a Price Tag on Synergy

Continuing with the example, suppose the fair market value of Company B is $1 million on a controlling basis. An appraiser might value the combination’s potential synergies at $300,000. To arrive at this synergistic value, the appraiser might have considered overhead reductions from combining sales, marketing, accounting, production and human resources functions. There also might be cross-selling opportunities between their customer lists and bulk purchasing discounts on raw materials that are available only to a larger combined entity. The buyer and the seller must decide together whether the price for the business will be $1 million, $1.3 million or some price in between.

Work starts before you put your business on the market, and you and your business valuation advisor form an important team. That will give you a chance to identify the potential synergies that might exist in your business to the right buyer and to assign a value to those synergies. As the owner and operator of the business, you have a unique perspective on what unrealized potential exists in your business, assuming there were no lack of resources or opportunities — that is, resources or opportunities which a potential buyer might possess.

Another business might be lacking in opportunities that can be provided by a merger with your business, or your business’s profitability might be enhanced by the opportunities provided by another potential buyer. Your advisor has the skills necessary to assign a dollar figure to the synergies once you have both identified them.

Pinpointing the Right Buyer

Identifying the right buyer who can maximize the value of a combination of the two businesses is another piece of the puzzle. If you do not search for that “right buyer,” you as the seller are probably passing up the opportunity to sell your business for a premium above fair market value.

Once again, you and your business valuation advisor form an important team to identify these potential synergistic buyers. You have the knowledge of your industry and the knowledge of what potential buyers could benefit from a combination of your two businesses. Your business valuation advisor can assist in identifying not only specific businesses and buyers but can also expand the pool of possible buyers.

For example, he or she might know institutional investors that specialize in your industry. Business valuators also have access to transaction databases, which enable them to research what comparable private firms have sold for recently, as well as the average price-to-cash flow or price-to-earnings multiples that acquisitive public companies have paid for comparable businesses.

When it comes to industry rules of thumb, valuators know about those too, and the reasons they might not apply to your business. This can be a valuable exercise. In the event that a buyer mentions a rule of thumb during negotiations, you’ll be prepared to explain why it does (or does not) apply.

Once the price negotiations begin with a potential buyer, your foreknowledge of the comparable transactions and potential synergies can place you in a superior bargaining position. The goal, of course, is to get more of the value of the synergies on your side of the ledger. On the other hand, if you enter negotiations unprepared, there’s a good chance the buyer will end up gaining more of the added value.

It Pays to Plan Ahead

Remember, the time to consult a business valuation advisor is before you put your company on the market and begin entertaining offers. Don’t go into the process unarmed with knowledge of market data or synergistic value — or you may unintentionally give away value that you’ve worked hard to build.