How Much Should a Buyer Pay a Seller for Synergies of two Merged Businesses?

This is an interesting question and the answer has certainly changed over the years. Whereas synergies may have previously been credited almost entirely to a buyer’s benefit, the recent trend has been for buyers to pay an increasing premium to sellers for some of the shared future synergies.

In most strategic deals, there is now more time spent analyzing and challenging the forward-looking synergies between two merged companies and consequently more time is spent negotiating the amount of the merged synergies that a seller could be compensated for at closing.

According to a recent study by the Boston Consulting Group, the seller now collects on average 31% of any agreed upon deal synergies. It seems that this 31% would be a difficult number to accurately report, given the uncertain determination of the denominator (the dollar amount and timing of any future synergies,) but it may be useful as a rule of thumb.

If this applies to your business, the first thing we would recommend is to thoroughly consider deal synergies when selling to a strategic buyer.

Interestingly and perhaps counterintuitively, the study showed that a buyer’s share price increased more for those deals where the buyer paid the seller a greater proportion of the future synergies. This could be explained by the fact that investors respond better to a strong fit between buyer and seller and highlights that many investors consider strategic fit to be more important than the purchase premium paid.

The Boston Consulting Group’s study also revealed that buyers with higher EBIT (earnings before interest and taxes) margins typically pay a higher proportion of synergies without seeing declines in their share price. In this case, the rationale is that a higher performing buyer may have a positive impact on the seller’s earnings.

What could acquisition synergies include?

It really depends on the unique business and industry, but typical deal synergies could include both cost reductions and revenue increases by combining two or more businesses. Examples could include G&A expense reduction, shared R&D expenses, centralization of production, reduced raw material costs through greater purchasing power, increased equipment utilization, technology utilization, process utilization, leveraging human talent strengths and cross-selling opportunities, to list but a few.

How could this work for a seller?

So, if the buyer is supposed to compensate the seller, how do both sides quantify and agree upon the synergies? How should a seller negotiate their share and when should a seller introduce the topic in the sale process?

First, as always, it comes down to hard work, analysis and preparation. It is imperative that the seller and their advisors do their homework and not only create a list of synergies, but also quantify each line item, the dollar amount and timing of when to apply that dollar amount to the forecast. This work needs to be robust and should be challenged and revised independently by a third party before presenting the analysis to the buyer.

Second, you need to present a clear summary and supporting detail of the synergies that are being proposed. A buyer will pick apart your assumptions, so make sure that you have data and analysis to substantiate each line item and the timing to apply the synergies. This is an opportunity to gain additional dollars at closing and even post closing, but it’s also occurring at a critical juncture in the sale process, typically shortly before closing, so it has to be handled professionally and with diplomacy.

At the very minimum, an analysis and discussion of synergies should increase a buyer’s appetite to get to the finish line and close the deal. More often than not, it can also provide a legitimate opportunity to carve out additional purchase price for the seller.

As with every sale process, each business and situation is unique and we would recommend seeking professional advice.