Company Valuation: Which Methods Determine the Price in a Mergers and Acquisitions Process?

Price in the Mergers and Acquisitions Process

Price is one of the most important items that the parties bring to the table in a mergers and acquisitions process. The buyer expects the amount paid for the target company to be consistent with the value it will create in the future. The seller, in turn, expects to receive a fair return on what has been built over the years. The tool that brings these two expectations onto common ground is company valuation. Company valuation is a structured exercise that translates a business's current position and future potential into a numerical framework, based on defined methods and assumptions.

Company valuation produces a range of values rather than a single figure. This range emerges from the combination of different methods and different assumptions. The final price is then settled within this range through negotiation between the parties. In this article we discuss the core methods used in company valuation, the data on which a valuation is built, and the way the resulting value turns into a price during a mergers and acquisitions process. For the overall framework, you may wish to read our article on the stages of a mergers and acquisitions process.

The Framework of Valuation Approaches: Which Core Methods Support Company Valuation

The methods used in company valuation practice are generally grouped under three main approaches: The income approach, the market approach and the asset approach. Each approach looks at the company from a different angle and seeks an answer to a different question. Using these approaches together in a mergers and acquisitions process helps the resulting value rest on a solid foundation.

The income approach focuses on the cash flows the company is expected to generate in the future. Its most common application is the discounted cash flow method. In this method, the free cash flows the company will produce in the coming years are forecast, and these amounts are brought to their present value using a discount rate. The discount rate reflects the company's cost of capital and the risks it carries. At the end of the forecast period, the value the company will create over its remaining life is captured through a terminal value calculation. This method is regarded as a detailed reflection of the company's own dynamics and growth plan. The result, however, is sensitive to the assumptions used. Small changes in inputs such as growth rate, profit margin and discount rate can have a noticeable effect on value.

The market approach assesses the company by relating it to similar companies and similar transactions. It has two main applications. The first is comparable company analysis, which uses the multiples at which similar listed companies trade. Multiples such as enterprise value / EBITDA, enterprise value / sales or price / earnings are commonly applied here. The second is precedent transaction analysis, which considers the multiples paid in recent mergers and acquisitions transactions in the same sector. Because precedent transactions show the prices actually paid in the market for that sector, they form a reference that is frequently used at the negotiation stage. The strength of the market approach is that it reflects the market's current pricing tendency. The point requiring care is that the selected comparables should be consistent with the target company in terms of scale, growth profile and geography.

The asset approach focuses on the value of the assets the company owns and the liabilities it carries. In this approach, balance sheet items are remeasured at market value, and net asset value is calculated by deducting liabilities from assets. In companies with substantial real estate, machinery or inventory, this approach can form a meaningful floor. In operating companies that generate cash, this method is often not considered sufficient on its own; elements that do not fully appear on the balance sheet, such as brand value, customer relationships and know-how, are only partially reflected.

In practice, company valuation exercises use these approaches together and combine the result of each method into a value range. This range is presented method by method on a summary chart, allowing the parties to see where value is concentrated. In a mergers and acquisitions process, a shared understanding of this range by both buyer and seller helps subsequent discussions proceed in a common language.

The Assumptions Behind the Numbers: Which Data Is Used to Prepare a Company Valuation

The reliability of a company valuation is directly linked to the quality of the data on which it rests. For this reason, the first step in a valuation exercise is to prepare the company's financial statements for valuation purposes. Historical income statements, balance sheets and cash flow statements are reviewed, and items that do not reflect the company's ordinary operations are separated out. This process is known as normalisation, and in a mergers and acquisitions process it is a stage that directly affects price.

Within normalisation, one-off income and expenses, payments to shareholders outside market terms, expenses unrelated to the company's activity, and related-party transactions between group companies are reassessed. The adjusted EBITDA that results from these corrections forms the starting point for both the multiples analysis and the cash flow projections. When the seller carries out and documents these adjustments internally before the process begins, the buyer reaches the same points more easily during due diligence and the negotiation moves faster.

Another core input in a company valuation is the forward-looking business plan. The business plan sets out the sales growth, margin development, investment needs and working capital requirements the company targets over the next three to five years. This plan is expected to be realistic, internally consistent and explainable in relation to past performance. The buyer often tests the assumptions in the business plan against its own scenarios and calculates separate values for different growth cases. Preparing each assumption in the business plan together with its rationale can therefore give the seller a strong position in the valuation process.

The main data groups considered in a valuation exercise can be summarised as follows:

→ Income statements, balance sheets and cash flow statements for the past three to five years

→ An adjusted EBITDA calculation that removes one-off and non-operating items

→ A business plan containing sales, margin, investment and working capital assumptions

→ A net debt calculation covering cash, financial debt and debt-like items

→ A normal working capital level determined with seasonality taken into account

→ Multiples of listed companies in the sector and data from recent precedent transactions

→ Risk-free rate, risk premium and cost of borrowing inputs used to determine the cost of capital

The net debt calculation holds a special place in a mergers and acquisitions process. Valuation methods often calculate enterprise value, that is, the value the company generates for all its capital providers. To arrive at equity value, the amount that will go to the selling shareholders, net debt is deducted from enterprise value. Net debt covers not only bank loans but also items that carry debt-like characteristics. Unpaid tax liabilities, deferred payments, severance provisions and lease obligations may be considered within this scope. Which items count as debt-like can become a point of negotiation between the parties and can have a visible effect on price.

Working capital plays a similar role. On taking over the company, the buyer expects sufficient working capital to be in place so that operations continue without interruption. The valuation exercise therefore determines the company's normal working capital level, and the actual level at the closing date is measured against this reference. When the closing level falls below the reference, the price may be adjusted downward; when it exceeds the reference, the price may be adjusted upward. For more detail on managing working capital, you may refer to our article on working capital and the cash cycle.

Findings from due diligence can also update valuation assumptions. Financial due diligence confirms the adjusted EBITDA and net debt calculations or proposes new adjustments. Tax, legal and operational due diligence identify potential liabilities. These findings are often handled through contractual mechanisms such as specific indemnities or escrow accounts rather than a direct reduction in price. In this way, company valuation and the contract structure function as two complementary tools.

From Value to Price: Which Role Does Company Valuation Play in the Negotiation Process

Company valuation produces a value range; the price is determined within that range by agreement between the parties. This distinction is important for managing a mergers and acquisitions process well. Value is a technical result based on methods and assumptions. Price is a negotiated outcome that combines this technical result with the strategic expectations of the parties, their bargaining positions and the structure of the transaction.

The amount a buyer is prepared to pay often consists of more than the standalone value of the target company. The buyer also takes into account the synergies that will emerge after the transaction. Cost savings, cross-selling opportunities, access to new markets and improved supply terms are among these synergies. How much of these synergies the buyer is willing to reflect in the price is one of the central topics of negotiation. Strategic investors and financial investors may adopt different approaches to pricing synergy potential; for this reason, understanding the profile of the investor it is talking to helps the seller position its valuation expectations correctly.

The structure of the transaction also comes into play when the price is set. Paying the entire price in cash at closing is not the only option. Part of the price can be structured as contingent consideration, paid according to the company's future performance. This practice is used to bridge the gap between the buyer's and the seller's expectations of the future. If the seller believes the business plan will be achieved, contingent consideration offers the opportunity to capture that part of the value. The buyer, in turn, manages its risk by tying part of the payment to actual results. The performance measure, the period covered and the calculation method for contingent consideration are defined clearly in the agreement.

The price mechanism itself is a separate topic in mergers and acquisitions agreements. Two main approaches are seen in practice. Under the closing accounts approach, the price is finalised after closing on the basis of net debt and working capital at the closing date. Under the locked box approach, the price is fixed at signing with reference to a specific historical balance sheet date, and the agreement provides assurance that no value leaves the company between that date and closing. Both approaches are internally consistent, and the choice between them is determined by the parties' priorities regarding certainty and flexibility.

Company valuation serves as a reference point for both parties throughout the negotiation. The buyer's price offer is measured against the seller's own valuation, and the assumptions behind any gap are identified. This gap usually appears at concrete points such as growth expectations, the choice of multiple or the definition of net debt items. Addressing these points one by one allows the parties to discuss the matter on technical grounds rather than personal expectations, and broadens the basis for agreement.

From the board's perspective, company valuation is the document underpinning the transaction decision. The board assesses whether the proposed price is supported by an independent valuation, whether the assumptions used are consistent with the company's actual position, and what risks the transaction structure carries for shareholders. Independent board members can make an important contribution at this stage by questioning valuation assumptions and ensuring the decision process is documented.

Preparation at the start of the process has a direct effect on price. A company that has put its financial statements in order, documented its adjustments, substantiated its business plan and set out its net debt items transparently holds a strong position in the valuation discussion. This preparation contributes both to defending a price in the upper region of the value range and to keeping any price adjustments after due diligence limited. The first step of this preparation is a holistic review of the company's current financial structure; our financial check up model offers a structured starting point on this subject.

Company valuation, in short, forms the technical backbone of a mergers and acquisitions process. A valuation prepared with the right methods, reliable data and clear assumptions enables the parties to find common ground on price, allows the transaction to be structured correctly and places the decision process on a solid foundation.

As NT Finans Partners, we work with organisations on preparing company valuation exercises in mergers and acquisitions processes, reviewing valuation assumptions, structuring net debt and working capital calculations, and supporting the board's decision process. You can contact us for your company's valuation preparation and transaction process.