As a valuation expert I often get asked, ‘should I overpay in order to close the deal?’ One of the main things I ask anyone asking this question is to consider the opportunity cost of not closing the deal. 

Being an expert in valuation I never want to say that valuation is not always the most important part of the purchasing process. However, in reality, I know that many things should be considered when deciding what to pay for a business and sometimes that leads to the conclusion that yes you should overpay for the opportunity. 

I see many search firms or potential buyers not close on deals for fear that they are overpaying for an opportunity even though they think the business is an excellent opportunity that doesn’t come around very often. 

Many of those same buyers have also been working full-time just searching for a business to purchase for two or more years because they didn’t want to risk overpaying for an opportunity. For those buyers, the cost of looking is not only time and years of not owning a company that is generating income, but in many cases, it’s lost salary or additional costs by paying buy-side advisors or employees to do the searching. 

If for example, those same buyers in year one had overpaid for an opportunity (for simplicity, say paying a multiple of 5X instead of 4X cashflow) they probably would be better off financially. By overpaying for a business at the outset, the buyer would have had 1 to 2 years of additional earnings, plus saving the additional costs of finding another opportunity. The additional earnings and savings would easily compensate for the additional 1 year of cash flow included in the overpaid price.

As much as it pains me to say it, the valuation (or fair market value), is not always the most important consideration when deciding to close a deal. Any potential purchaser should consider things such as opportunity cost, the fit of the opportunity, their current situation etc. Even making no decision is itself a decision with costs, keeping realistic and flexible expectations is crucial in this competitive market. 

 

Ryan Buist

VP of M&A and Valuations

Portage M&A Advisory