Do I Buy The Assets Or The Shares In The Company I Want To Buy (“The Target”)

In a nutshell, do I buy the Target's physical assets at their market value or do I buy the shares in this company? If you are buying a business outright, then typically you'd purchase the shares in that company because they're worth more. But if you're just buying out a shareholder who owns those shares then the value of their stock is what'll drive your transaction price.

In order to answer this question, let’s break down how it would go down:

- You want to buy 100% of The Target on the open market at $10 per share.

- The Target’s current shareholders own 90% of the company and these shares are currently trading at $16 a share.

- The 10% stake that’s available for purchase is valued at $1.60 per share, so your total transaction value would be $10 + 90% * 16 + 10% * 1.60 = $30 per share.

- So you might as well just buy the current shareholders' shares in this business and pick up that extra 50% that would be worth an extra 60 cents or so per share before you even start working on the business, right? Uh.. maybe not.

If you buy the shareholders' shares then you're buying a relationship that's already been created, but it's a relationship in which the shareholder owns 90% of the Target and does not have to pay for any additional costs of doing business beyond their (in-kind) labor. The shareholders have provided this cost-free labor to the Target by taking on all their potential losses on behalf of the Target for their first 5 years in business.

If you're not paying for this exchange then you can buy the company's shares at $16 per share, which is 90% of the Target’s total value. But the Target is not worth that entire $16 per share in total, or even 10% of that number either.

How much The Target is worth will depend on how much it costs you to acquire 100% ownership. You are basically exercising your options, in a way.

So if you have to pay an estimated $3 million to buy out all of the shareholders’ shares, then that would bring our transaction price to $10 + 20% * 16 + 80% * 1.60 + $3 million = $29.60 per share.

There are a number of factors that you'll need to consider when considering how much you're going to pay for the Target’s physical assets:

- What do your numbers look like? If your numbers (GPV) and their numbers (adjusted EBITDA) are comparable, then they won't be able to leverage their stake in the company any more than you will and the transaction price will be set by the open market price of their shares and not by what you'd be paying them.

- How long have they been in business? If they've been in business longer than you and the current owners, then they'll be able to gain that additional time premium on each one of their shares.

- What's their financial situation like? If they have a lot of debt or some other aggressive financing, then you might need to pay more to take them out.

- How much do you actually know about this buyer? Do you trust them to pick up the rest of the litter if something happens to you? Because if not, then maybe you should try and get them to pay more than the open market rate for their shares because it's in your best interest. I'd always prefer to know more before I pay more.

- How much is your reputation worth? If they don't mind paying the price you want, then it might be in your best interest to pay them whatever they want. But if they're not that into you, this might just make them even less willing to pay because now you're asking them to pay more for the Target and their only motivation goes out the window. And that’s a bad thing when it comes to buying a business. (See: Ratios & Financial Forecasts; Power Law of Compensation )

So obviously this is going to vary depending on which factors are most important to you or your buyer. This can get very subjective in some cases.

But should you be willing to pay more to take out a buyer who's less able to help you with their share of the business or profitability? Maybe not.

In this case, if the seller is better at picking up the financial slack and taking losses, then that'll save you from having to raise more money. You can raise more money in multiple ways, but only one of them has a chance of being profitable and that's when you can buy a business for its fair value and not have to pay so much for it. When buying a company at its fair value it also means your margins (and profits) will grow as your company is able to generate a lot more sales per employee per dollar on their behalf.

So while you're trying to read your buyer, they're also trying to read you. Which means that if you want to come off as politically savvy and like a strong negotiator, something like this announcement can make a big impact.

Let's say that you want to raise $1 million for your company and the buyer on the other side of the table wants in for $250,000. And we'll assume that both of these figures would be reasonable for their role in the company at this point in time based on your respective GPV/adjusted EBITDA ratios. This can get very subjective in some cases.

In order to get them to have to pay more, the seller might just decide that it's time for them to lose their investment in the Target. So he has been holding back on bidding lower because he knows that you don't have enough money and that you're getting a bit desperate. (See: Sensible vs Irresponsible Negotiation; Power Law of Compensation)

He then decides that $250,000 is entirely within reason and his personal risk profile is being kept in check by the fact that your company is still a good many years away from being profitable. He's also going to make sure by putting in a low bid that this doesn't look like "a put up deal" or anything like that.

The only way to get them to accept your bid is to (1) offer them a bit more cash for their shares than they're worth, or (2) make it look like you have a lot more money than you really do.

So what can you do here? Well, your best bet is to come right out and say that you're interested in buying at the current market price. And then just let them know that they don't have to sell. It may not seem like a great deal for someone who's getting 0% in a CD right now, but some people will accept this as an opportunity when there's no real risk involved.

Conclusion

So this is all about knowing how to utilize the environment around you. And that’s something that you’ll only get a better feel for over time by getting more comfortable with the business of deal-making itself.

The strategy here is to find out as much as you can about your target while not revealing that you're trying to do so. You'll also want to keep in mind that the opposite party is in control of the situation here and that they can be equally crafty when it comes time for them to make their bid too. (See: Why You Can't Win at Poker) So make sure that you're always following suit and don't get caught up in their little games either.