Acquisition Premium - What is it, and How to Calculate it?

An acquisition premium expresses the difference between the price paid for a firm and the value of the firm.

For example, suppose a firm is valued at $ 1 million. Suppose an investor also purchased the firm for $ 1.1 million. In our example, the difference between the purchase price and the firm's value equals $ 0.1 million and is called the acquisition premium.

The acquisition premium cannot be negative. If the price to be paid for the firm is $ 0.9 million, the difference is negative and is worth minus $ 0.1 million. In this case, it is not an acquisition premium (but a discount).

Why Investors will agree to Pay an Acquisition Premium?

• There are four reasons buyers will agree to pay for an acquisition premium - multiple bids, shareholders' refusal to sell firm ownership, synergy, and competitive advantages. 
• Other bidders. When additional potential buyers are interested in acquiring the company, the potential buyer will have no choice but to pay a higher price than the value to gain ownership of the firm. This price will equal the amount of the firm's value plus the purchase premium.
• Shareholder reluctance. When a shareholder refuses to sell his share in the company, a potential buyer will be able to try to persuade him to sell. To this end, it can offer a higher price than the value. The increase in value will be called the purchase premium.
• Synergies. Suppose the acquirer thinks it can achieve significant synergies by buying the target company. In that case, it will be more interested in paying a higher price to ensure the deal.
• Competitive advantages. When a potential buyer believes that the company has a relative advantage, he will be willing to pay a premium for this comparative advantage. An example of a competitive advantage can be, for example, the ability to purchase raw materials cheaply.

Acquisition Premium - The Formula

The formula of the acquisition premium is the difference between the price of the target company and the value of the target company, divided by the value of the target company:

(P - V) / V

Where:

P = The price of the target company

V = The value of the target company

Conclusion

Suppose you want to calculate the company's value quickly and without a problem. In that case, you are welcome to use our business valuation software or our business valuation calculator.