Acquisition premium is the difference in price between the amount paid for a company and its evaluated market value.
What Is Acquisition Premium?
An acquisition premium is a difference between a buyer’s price for a target firm over its assessed fair price. It represents how much the acquiring firm paid more over a company’s fair value. An acquisition premium, called goodwill, is kept on the buyer’s balance sheet as an intangible asset post-acquisition.
Importance of Acquisition Premium
An acquisition premium only arises when the target firm is bought for more than its fair market value. Otherwise, it could be sold for less than its market price. Such a situation will only arise when no other bidder expresses interest in the firm, or the existing shareholders are in immediate need of cash. There are different reasons to pay an acquisition premium, such as:
If other bidders are bidding for the target firm, the buyer may need to pay over the fair market value to ensure their bid wins.
Reluctance by Shareholders
Shareholders may not be willing to sell their shares, especially when it comes to family-owned enterprises. As a result, a premium is paid to make them more willing to sell.
If buyers think their purchase will help them achieve synergies, they will more likely pay a premium to ensure the deal persists.
A buyer may believe that a purchase will give them a unique competitive advantage. For instance, it could provide them with access to unique IP, a highly skilled team and a monopoly over the market.
How Does an Acquisition Premium Work?
When a company wants to buy another, it first estimates the target firm’s value. Once it is done with its assessment, it will decide how much it is willing to pay on top of the assessed value to make the deal attractive to its buyers. This is especially so if other firms are interested in buying the target company.
What Exactly Is Goodwill?
Goodwill refers to a firm’s specific intangible assets that include its brand name, stakeholder relations, patents and reputation. Goodwill can go down when the market value of an intangible asset drops below its acquisition costs. A buyer could also buy a firm for less than its fair market value, leading to a negative goodwill balance.