Every dealmaker has faced it: the elusive valuation gap that turns promising negotiations into drawn-out debates. In mergers and acquisitions (M&A), the negotiation process often hinges on one key question: What is the business worth?

While both buyers and sellers may start with the same formula, such as multiplying EBITDA by an industry-standard multiple—their perceptions of value can diverge significantly. This difference, known as the valuation gap, is a fundamental challenge in deal-making. Without it, there would be no need for earn-outs or other creative solutions to bridge the gap.

So, why do these valuation gaps arise? Let’s explore the factors driving them from both the buyer’s and seller’s perspectives and how to navigate them effectively.

1. Differing Perceptions of Risk: Finding the Balance

Buyer’s Perspective: Minimizing Downside Risk Buyers are naturally cautious. They’re taking on the risk of operating the business post-acquisition, which could include:

• Future performance uncertainty: Can the company sustain or grow its earnings?
• Operational risks: Will key employees and customers stay?
• Market risks: How will competition, economic shifts, or regulatory changes impact the business?

Given these uncertainties, buyers often take a conservative approach to valuation. They may:

• Discount future earnings.
• Adjust EBITDA downward for perceived risks.
• Offer lower multiples compared to what the seller expects.

Seller’s Perspective: Optimizing Upside Potential Sellers, on the other hand, have typically spent years building the business and have a more optimistic view of its future. They may argue:

• Growth is imminent: New product launches or market expansions will drive revenue.
• The business is resilient: Past performance demonstrates the ability to weather risks.
• Synergies with the buyer: The business’s value will increase when integrated with the buyer’s operations.

This optimism often leads sellers to push for a higher valuation, reflecting what they believe the business will achieve, not just what it has done historically.

2. EBITDA Adjustments: Bridging Financial Perspectives

EBITDA may be the standard starting point for valuations, but pro forma adjustments often create significant friction between buyers and sellers.

Buyer’s View: Scrutiny of Adjustments Buyers tend to accept only adjustments they believe are legitimate and sustainable, often pushing back on:

• Add-backs for non-recurring expenses.
• Projections of cost savings or revenue increases tied to synergies.

Seller’s View: Highlighting Earning Potential Sellers, in contrast, use adjustments to showcase the company’s “true” earning power, such as:

• Removing owner-specific expenses (e.g., above-market compensation).
• Highlighting cost reductions already in progress.

Example: If a seller claims a $1 million EBITDA adjustment for future cost savings, the buyer may argue these savings aren’t guaranteed and should not be included in the valuation.

3. Synergies: A Shared Opportunity

Buyer’s Perspective: Paying for What Exists Today Buyers are hesitant to pay for synergies they will create post-acquisition, such as:

• Cost savings from shared services.
• Increased revenue from cross-selling.
• Operational efficiencies through integration.

Their position: Synergies are speculative and should benefit the buyer, not inflate the seller’s valuation.

Seller’s Perspective: Sharing the Synergy Value Sellers argue that the buyer wouldn’t consider the acquisition if these synergies didn’t exist. They believe the buyer should share the value of synergies in the purchase price, as they’re a direct result of the seller’s business model or assets.

4. Emotional and Strategic Factors: Navigating Subjectivity

Seller’s Emotional Investment For many sellers, especially founders, the business is more than just numbers—it’s their life’s work. This emotional attachment often leads to a premium expectation in valuation, which buyers may view as unjustified.

Buyer’s Strategic Fit If the acquisition is critical for the buyer’s strategic goals (e.g., entering a new market or acquiring unique technology), the seller may leverage this importance to push for a higher price.

5. Market Dynamics: Timing Is Everything

The broader economic environment also plays a role:

• Buyers may be conservative during periods of market uncertainty, applying lower multiples.
• Sellers may push for higher valuations in booming markets, expecting premium multiples.

Additionally, deal timing matters. If the seller is under pressure to exit quickly (e.g., due to retirement or financial distress), they may accept a lower valuation. Conversely, a buyer under strategic pressure may pay more to secure the deal.

Conclusion: Bridging the Valuation Gap

Valuation gaps are a natural part of M&A negotiations, driven by differences in risk perception, growth expectations, and market dynamics. Recognizing why these gaps exist is the first step in resolving them by creative solutions such as earn-outs, seller financing, or deferred payments to align their interests.

In my next article, we’ll dive deeper into these solutions and how they help close the valuation gap while protecting both buyers and sellers.

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