That’s the most we can pay! - Capital-Riesgo.es

What Does a “Good Price” Really Mean When Someone Wants to Buy Your Company?

At least once a month I receive a call from a business owner who has an offer on the table to buy their company.

They tell me they were contacted by an industrial company or a private equity fund that had been analyzing the sector. After some initial conversations, they signed an NDA, exchanged some information, and a few weeks later an offer arrived.

For example, €12 million.

€9 million at closing.

An obligation to reinvest €2 million into the buyer’s parent company.

And another €3 million in the form of an earn-out.

The entrepreneur explains that their company installs and maintains sensors in elevators, water pumps, HVAC systems, and electrical systems. They generate about €15 million in revenue and around €2 million in EBITDA.

There are three partners, and they are considering whether to sign the letter of intent the potential buyer has sent them. The first offer was €10 million. After negotiating, they reached €12 million. The buyer has said that this is the maximum they can pay. If they want more, they will walk away.

At some point in the conversation, the question I was expecting eventually appears:

“Joshua, what do you think?
Is the offer they made me a good one?”

It’s a very reasonable question. I imagine I would ask the same thing (and I did in my previous life as a tech entrepreneur before I started advising others).

The problem is that when it comes to a company, there isn’t a quick answer.

Valuations help, but they don’t answer the question

What the entrepreneur who asked me the question really wants is a quick answer like:

“Companies in this sector usually trade at around 7x EBITDA, so it’s a bit low.”

Unfortunately, a company doesn’t have an objective price like a house with an appraisal (although I’ve seen several websites advertising company valuations in three minutes).

One way to approximate that value is to conduct a formal valuation, usually combining several methodologies.

One of them is discounted cash flow analysis. Essentially, it consists of estimating how much money the company will generate in the future and bringing those cash flows back to present value using a discount rate that reflects the risk.

Another approach is to analyze comparable transactions in the sector. When public data exists, you can observe the EBITDA, revenue, or earnings multiples paid in other deals.

You can also look at relatively similar publicly listed companies. In that case, their trading multiples are used as a reference and then adjusted for size, liquidity, and risk, because a small private company is usually not valued the same as a much larger public company.

In practice, when a serious valuation is conducted, these three approaches are typically combined to arrive at a reasonable valuation range. None of them alone gives a perfect answer, but together they help provide a rough reference.

All of that can help provide orientation. However, reality is simpler on the surface — but in fact much more complex underneath.

Price only exists when there is a market

Borrowing the words of the economist Ludwig von Mises (1949):

“Prices are the outcome of the actions of individuals in the market.”

In other words, price is not an abstract figure that can simply be calculated on paper. It is the result of real people making real decisions about how much they are willing to pay.

This principle applies to almost everything that is bought and sold: consumer goods, services, publicly traded stocks, bonds, and any other financial asset — and, of course, companies in M&A transactions.

That is why, when an entrepreneur asks me whether the price they have been offered for their company is appropriate, the question is not really about the supposed intrinsic value of the company.

The real question is this:

“How much would someone be willing to pay for this company, as it is today, at this specific moment?”

For a market price to exist, there actually has to be a market. That means there must be a sufficient number of qualified buyers analyzing the company and deciding whether to submit an offer.

When there is only one offer, the only thing we know for certain is how much that particular buyer is willing to pay for that specific company at that particular moment. Any other reference we construct — based on theoretical valuations, comparables, or financial models — remains, at its core, a reasoned estimate.

The only way to truly discover the market price of a company is to put it in front of several potential buyers and see how they react.

In processes like this I have seen differences between offers that, at first glance, are difficult to explain. In some cases the highest and lowest offers were separated by barely 15%. In others, one or two buyers appeared willing to pay 50% more than the rest. I have also seen processes in which four offers were quite similar — and then suddenly a fifth appeared that nearly doubled the others.

What’s interesting is that the company was exactly the same for all buyers, and the financial projections they analyzed were also the same. The difference had to do with how the company fit into each buyer’s strategy. For some it represented clear operational synergies. For others it meant access to certain clients or the possibility of entering a new market. And in some cases it simply coincided with a strategic moment in which the buyer had a particular interest in moving forward.

This combination of factors often explains why one buyer is willing to pay significantly more than another for exactly the same company. Ultimately, it is the market that determines the price through the interaction of multiple buyers within a competitive process.

When the question is whether the price is right

Going back to the starting point, whenever someone asks me whether the price they have been offered for their company is the right one, I remember something my wife has been telling me for years, somewhat jokingly. She says I should have gone on the TV show The Price Is Right, because I have a certain talent for guessing prices. Many times when she buys something for the house or for our daughters she asks me how much I think it costs — and surprisingly often I get it right.

The problem is that with companies, that “talent” is not very useful. In the world of M&A, price information is very limited, many transactions are not public, and the market changes quickly. Even when you have references from other deals, they often stop being useful because the company is different, the buyer is different, or the market moment is different.

That is why, when an entrepreneur asks me whether the offer they have on the table is the right price, I usually have no choice but to return the question: