Bridging the Valuation Gap: How Deal Structure Can Salvage an M&A Impasse

Mergers and acquisitions are heating up across the wealth management landscape. Some firms are building pipelines as serial acquirers. Others are testing the waters—exploring a single deal or even contemplating the possibility of being acquired. Regardless of where you fall on that spectrum, one constant remains: valuation can make or break a deal.

According to recent Cerulli research, the number of advisory firms considering a transaction—either acquiring or being acquired—has reached record levels. However, with more deals comes increased friction around valuation. That’s why we’re starting here.

A few years ago, I was coaching two firms attempting to merge—one enthusiastic about the future, the other cautious and conservative. They were $12 million apart in valuation. Deadlocked. However, the breakthrough didn’t stem from debating the numbers—it originated from rethinking the deal structure.

This article isn’t designed to provide the final word on M&A; instead, it serves as a starting point—an invitation to think differently about how deal structure can bridge valuation gaps and create a path forward. We will continue to explore this topic from multiple angles in the months ahead, but for now, we invite you to consider a few practical ways to keep deals alive and aligned.

Mergers and acquisitions (M&A) are inherently complex transactions, with a fundamental challenge in reconciling often vastly differing valuations between the buyer and seller. This ‘valuation gap’ isn't merely about disagreement on a number; it arises from fundamentally different perspectives, assumptions, and strategic priorities. Too often, these discrepancies lead to potential deals imploding long before either party has a chance to engage in meaningful dialogue. However, a well-structured transaction can help bridge the divide and create a win-win scenario that both parties can embrace.

Let’s explore some of the underlying reasons why valuations often diverge and how the appropriate deal structure can align the buyer and seller.

Let’s start with where the friction usually begins. 6 Reasons Why Valuations Often Diverge

While revenue is a crucial aspect of every valuation, it is not the only factor. Disagreements regarding other valuation drivers can stem from various sources, perceptions, and differing assumptions, such as:

1. Differing Growth Projections: Sellers often project optimistic future growth based on recent performance or expected market trends. Buyers, adopting a more cautious approach, might discount these projections due to market volatility, competitive pressures, or integration risks. This results in a fundamental disagreement regarding future cash flows, which is a core component of most valuation models.

2. Varying Cost of Capital Assumptions: The discount rate used in discounted cash flow (DCF) analysis reflects the risk associated with an investment. Buyers and sellers may perceive this risk differently, leading to varying discount rates and, consequently, different valuations. A buyer might view higher risk due to integration challenges or market uncertainties, resulting in a higher discount rate and a lower valuation.

3. Strategic Synergies vs. Standalone Value: Buyers often justify higher valuations by projecting synergies—cost savings, revenue enhancements, or market share gains—resulting from the acquisition. However, sellers typically focus on the standalone value of their business. This difference in perspective can create a significant valuation gap.

4. Control Premium vs. Minority Discount: In acquisitions, the buyer often pays a "control premium" to gain the ability to control the acquired company's operations and strategy. Conversely, if the seller retains a minority stake, a "minority discount" may apply to their portion of the valuation. These adjustments can further complicate valuation discussions.

5. Market Conditions and Comparables: The availability of comparable transactions can influence valuations. However, identifying truly comparable companies is often challenging, and varying interpretations of market data can result in divergent conclusions.

6. Mischaracterizations of Tax Treatment: Not all M&A transactions are treated the same for tax purposes. While earn-out arrangements are taxed as ordinary income to the seller, other structures (e.g., deals that purchase the underlying business assets) may be considered capital transactions that qualify for long-term capital gains treatment. Typically, the treatment most favorable to a seller is least favorable to the buyer – often leading buyers to be willing to pay more for a deal with favorable tax treatment for themselves, while sellers may accept less to gain a more favorable tax outcome on their side.

If you’re serious about building a business with lasting enterprise value, your ability to think creatively during negotiations—especially regarding valuation—can be a game-changer.

Deal Structure as a Bridge: Transforming Valuation Differences into Opportunities

Instead of seeing valuation as a fixed point of contention, smart deal structuring can turn it into a flexible element that addresses the legitimate concerns of both parties. Here are five key mechanisms you might consider incorporating into your deal structure:

1. Earnouts: These contingent payments resolve disagreements regarding future performance. If the acquired business meets pre-agreed milestones (e.g., revenue targets, profitability thresholds), the seller receives additional payments. This aligns incentives and reduces the buyer's risk of overpaying based on overly optimistic projections.

2. Escrows: A portion of the purchase price is held in escrow for a specified period to cover potential liabilities or breaches of representations and warranties. This protects the buyer from unforeseen risks and gives the seller assurance of receiving the full agreed-upon price, subject to any claims.

3. Stock Consideration: Using stock as part or all of the purchase price can bridge a valuation gap by aligning the seller's interests with the future success of the combined company. If the buyer's stock performs well after the acquisition, the seller benefits from the increased value of shares. This approach can be especially appealing in high-growth companies.

4. Seller Financing: The seller offers a loan to the buyer to cover part of the acquisition. This shows the seller's confidence in the business's future performance and can help close a valuation gap by lowering the buyer's initial cash outlay.

5. Adjustments to Working Capital: Disagreements regarding working capital levels at closing can be managed through post-closing adjustments. This guarantees that the buyer receives a suitable amount of working capital to run the business effectively.

Case Study: Meeting in the Middle

Seller X values her advisory business at $50 million, based on fairly aggressive growth projections. In contrast, Buyer Y estimates the company’s value at $40 million, utilizing a more conservative growth projection model.

Neither party is showing flexibility or a willingness to find common ground on their valuation estimates. Instead of pushing away from the table and abandoning the deal, they could devise a deal structure that accommodates both sides by agreeing to a $40 million upfront payment, along with a $10 million earnout provision tied to reaching specific revenue targets over the next three years. This structure effectively bridges the $10 million gap – incentivizing the seller to drive future growth while protecting the buyer from overpaying if the seller’s aggressive growth projections are not met.

Conclusion

Remember that a valuation is merely a starting point representing the intrinsic value of the business. It’s an attempt to assign an arbitrary amount that reflects the stability, sustainability, and revenue predictability of a firm. However, a host of factors- from the skills and expertise of your team members to the diversity of your client base- will all play a role in the final equation.

Valuation discrepancies are a natural part of M&A negotiations; however, they need not be deal-breakers. By understanding the underlying reasons for these differences and employing creative deal structuring techniques, both buyers and sellers can bridge the valuation gap, align their interests, and create mutually beneficial outcomes. Focusing on the valuation process and how it influences the structure of the deal is key to ensuring a successful M&A transaction.

In a future article, we’ll address what makes a firm genuinely prepared to acquire—or be acquired. For now, just know that the ability to bridge a valuation gap is a skill worth refining.

Whether you’re a serial acquirer or just contemplating your first deal, remember that the best business builders don’t let valuation gaps hinder opportunities. They explore, listen, and structure their way to alignment. If today’s article sparked an idea or a question, feel free to send me a message; I’d welcome the chance to hear your thoughts.

COACHING QUESTIONS

1. What factors and qualities would qualify a firm as an ‘ideal fit’ for your existing organization in the context of a merger or acquisition candidate?
2. Are there issues you could start addressing now (for example, building capacity, upgrading technology, etc.) that might better position the business to engage in future mergers and acquisitions?
3. What are the factors you believe will most positively or negatively impact the value of your business, and how can you start to steer them in the right direction?

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