Acquisition Premium (Takeover Premium)

Complete Takeover Premium Guide with Example Explanations

What is Acquisition Premium?

The acquisition premium, also known as the takeover premium, is the difference between the actual price paid for a target company during a merger or acquisition based on its pre-merger value.

A premium is commonly paid if the acquirer has identified potential synergies resulting from the transaction that will offset the cost of the premium paid.

Takeover Premium Formula

The takeover premium (acquisition premium) formula is calculated by subtracting the value before merger from the total amount paid by the acquirer.

Here is the formula

TP = Amount Paid – Pre Merger Value


Amount Paid: The total cost of purchasing or merging with the target company. It can be expressed in terms of the equity value of the transaction or the full value paid for both the company’s equity and debt.

Pre-Merger Value: The market value of the firm before the transaction was brought.

Key Takeaways

Incentive for Shareholders: Acquisition takeover premiums serve as an incentive for shareholders to sell their shares by offering them compensation above the current market value, ensuring the success of the acquisition.

Reflection of Value and Synergy: The size of a takeover premium often reflects the acquiring company’s assessment of the target’s intrinsic value and the expected synergies from the merger, indicating the strategic importance of the acquisition.

Impact on Acquisition Costs: While takeover premiums can make acquisitions more appealing to target company shareholders, they also significantly increase the overall cost of the acquisition for the buyer, impacting the financial structure and post-acquisition integration strategy.

Why would a company pay an acquisition premium?

An acquirer is willing to pay for an acquisition premium because of the potential synergies that will be created as a result of the merger or acquisition. These synergies derive from the combination of both businesses and will only be achieved if the process is completed successfully.

The pre-merger market value of the firm is, therefore, considered lower since it doesn’t account from these synergies. As long as the value created by these synergies is higher than the acquisition premium, the acquirer should be willing to pay it.


Takeover Premiums and Synergies

Here are some of the usual synergies that can be created as a result of an M&A operation:

Cost savings

The combination of both operations could lead to economies of scale and an improved bargaining position for the resulting enterprise. In this sense, a cost-savings synergy would justify an acquisition premium.

Financial analysts usually forecast how the total costs of the merged businesses would look like if the transaction moves forward and the ideal result should be higher profit margins.

Revenue increases

By combining their client’s databases, distribution channels, marketing programs, and other sales tools, merged companies can ultimately produce a revenue increase that surpasses their individual capacities. This revenue increase should lead to higher earnings and, therefore, an acquisition premium would be justified up to the point that it is covered by the excess revenues and earnings created as a result of the operation.

Increase efficiencies

There are instances when patented or highly complex technologies can be the reason why a company decides to acquire another firm, as these could help the businesses improve its productivity and overall efficiency. In those cases, the synergy should generate lower costs, faster processes, and improved structures that could result in a reduction in costs, a higher quality, or larger earnings.

Acquisition Premium Takeover Example Calculations

Depending on the way the M&A is appraised, the calculation of the takeover premium can be analyzed based on the equity portion acquired or the full value of the target company.

Let’s say Eagle Constructions is looking to purchase a company called Leaf Suppliers, which is a company that commercializes wooden materials for construction businesses. Leaf Suppliers shares are being traded at $12.6 right now and Eagle Constructions is offering $15 to complete the transaction.

On the other hand, based on the market value of Leaf Suppliers, its current Enterprise Value is $3.39 billion. From this perspective, Eagle Construction is offering $4 billion to settle the deal. By using the following two formulas we can calculated the Acquisition Premium paid on the equity and the Enterprise Value, as follows:

Example using share price

TP = (Proposed price per share – Current price per share) / Current price per share

TP = ($15 – $12.6) / $12.6 = 19.0%

Example using enterprise value

TP = (Proposed Offer – EV) / EV

TP = ($4.0 – $3.39) / $3.39 = 18.0%

This means that Eagle constructions is paying an acquisition premium of 19% on the equity and 18% on the Enterprise Value (EV) of the firm. Eagle Constructions expects that as a result of these operations the costs of their projects would be reduced by more than 5% aas they will be able to secure lower costs from the newly incorporated wooden material business unit created from the acquisition.

What Factors affect Takeover premium value?

The takeover premium is mainly affected by the financial impact of the synergies created as a result of the M&A operation, along with the complexity involved in completing the transaction successfully.

If the forecasted financial impact of the M&A on the acquirer’s finances is significantly positive, the takeover premium will be higher. On the other hand, if the complexity of the deal is high, the acquirer may feel less prompted to offer a large premium as there’s a significant risk associated to the completion of the M&A.

Additionally, the existence of other potential acquirers that would compete for the deal could boost the takeover premium as acquirers could be more inclined to bid higher prices to secure the acquisition.

What is the right acquisition premium price?

The acquisition premium should be estimated based on a comprehensive analysis of the financial value of the potential synergies.

A 5 to 10 year forecast of the financial contribution of the synergies and a subsequent discounted value of the resulting figures could provide a maximum limit for the acquisition premium. If the acquirer goes beyond this value, the transaction will be seeing as a overvalued.

Where is the takeover premium recorded on the acquirer’s books in accounting?

After the consolidation of the acquirer’s and the target company’s financial statements occur, the takeover premium will be recorded as goodwill in the acquirer’s Balance Sheet.

This goodwill will be amortized against earnings for a certain period of time that is usually in line with the time horizon during which the company will receive the financial contribution of the synergies created as a result of the M&A.

Bottom Line

Acquisition premiums are also used as a way to entice the target company’s shareholders to approve the deal and, while they are an standard practice in the M&A industry, the must be carefully calculated as they could result in financial losses for the acquirer if the deal is significantly overpaid.

Frequently Asked Questions

What is an acquisition takeover premium?

An acquisition takeover premium refers to the extra amount an acquiring company pays over the current market value of the target company’s shares to purchase and gain control of it.

How is the takeover premium calculated in an acquisition?

The takeover premium is calculated by subtracting the target company’s stock price before the acquisition announcement from the offer price, then dividing by the pre-announcement stock price and multiplying by 100 to get a percentage.

Why do companies pay a premium in acquisitions?

Companies pay a premium in acquisitions to incentivize shareholders to sell their shares, compensating them for potential future gains they forego as a result of the acquisition.

Can the size of a takeover premium indicate the acquiring company’s outlook on the deal?

Yes, a higher takeover premium can indicate the acquiring company’s strong belief in the strategic value or synergy potential of the acquisition, suggesting a positive outlook on the deal’s benefits

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