Definition of Valuation Premium
A valuation premium refers to the excess in value that a buyer estimates for a company compared to its peers in the same industry.
Explanation of Valuation Premium
Buyers will typically review comparable transactions as part of their attentiveness prior to completing an acquisition. This review provides a range of multiples that is being applied to most transactions. If the buyer is willing to pay above or at the high end of this range, it means the target company has compelling attributes to justify a valuation premium.
Buyers pay a valuation premium for many reasons. However, these reasons usually fall into the following five categories:
The company has specific barriers to entry that make it increasingly difficult for additional competitors to enter the market;
The company has consistently delivered higher margins that its competitors, and has earned higher returns on investment;
The company has a specific proprietary technology that is difficult to replicate and/or is patented giving it a major competitive advantage;
The company is a particularly good fit with the buyer, either because its services open up new market opportunities, or because the management team perfectly fits the buyer’s growth plans; and
The company has access to customers that the buyer does not, and there is an opportunity to leverage off this customer list to cross sells the services or goods that the buyer sells.