In business combinations, it frequently happens that the acquirer can find “synergies” between its business and the “acquiree” (the target business that is being acquired).
Synergies generally refers to the cost savings that result from combining two businesses.
When two or more businesses combine, cost savings can often be made by, for example, combining the marketing or accounting functions. The whole therefore becomes greater than the sum of the parts.
From a valuation perspective, the question is whether the synergistic value should be included in the fair market value of the acquiree. The short (theoretical) answer is no; on a stand-alone basis there is no way that the target business can justify adding to its value. The additional value only results from the transaction and thus most correctly belongs with the acquirer.
In practice, synergies are the subject of negotiation. The target business should, in many cases, recognize that that the acquirer will realize cost savings because of the transaction and the seller could therefore negotiate to have some of these savings reflected in a higher purchase price. From the perspective of the acquirer, synergies provide some immediate benefits from the acquisition and thus allow the acquirer to pay a higher price than if there were no synergies.
Synergies may thus add to the price paid for the target business; however, this does not necessarily mean that they affect the stand-alone fair market value of the target, being the most likely price that would be paid by an acquirer that is unable to realize any synergies.
Synergies are a key reason why it is often better to find a buyer within the same industry, as opposed to a financial buyer (e.g. private equity firm).
Contact MVI to discuss how synergies may adjust the price paid for a business without affecting its fair market value. For a more in depth look at the differences between price and fair market value, go to Price v FMV