“Acquisition premium,” also known as a takeover premium or control premium, is a financial term that represents the additional cost a company is willing to pay when acquiring another company through a merger or acquisition (M&A) transaction. This premium is offered to entice the shareholders of the target company to agree to the deal. The acquisition premium is calculated as a percentage and is expressed as the amount by which the purchase price per share exceeds the current market price per share.
Purpose of Acquisition Premium
The primary purpose of an acquisition premium is to incentivize the shareholders of the target company to sell their shares and approve the acquisition. It serves as a financial incentive, offering shareholders more than the current market value of their shares to gain their approval.
Attraction: Acquiring companies may offer an acquisition premium to entice the shareholders of the target company to agree to the merger or acquisition. It serves as an incentive for shareholders to sell their shares.
Control: The premium reflects the value placed on gaining control and influence over the target company, which could include access to its assets, customer base, technology, or other strategic advantages.
Calculation
To calculate the acquisition premium, you use the following formula:
Acquisition Premium = (Purchase Price per Share – Current Market Price per Share) / Current Market Price per Share
For example, if a company offers to purchase another company’s shares at $50 per share, and the current market price of those shares is $40, the acquisition premium would be calculated as:
Acquisition Premium = ($50 – $40) / $40 = 25%
In this case, the acquisition premium is 25%.
Factors Influencing Acquisition Premium
Strategic Value: Companies may be willing to pay a premium if they see strategic benefits in the acquisition, such as synergies, access to new markets, technology, or cost savings.
Competitive Bidding: If multiple companies are interested in acquiring the same target, a bidding war can drive up the acquisition premium as companies try to outbid each other to win the deal.
Market Conditions: Economic conditions, industry trends, and overall market sentiment can influence the level of acquisition premium. In a strong economy, acquisition premiums may be higher.
Importance of Acquisition Premium
Shareholder Approval: Understanding the acquisition premium is crucial for target company shareholders when deciding whether to accept an acquisition offer. A higher premium may make the offer more appealing.
Valuation: It plays a significant role in the valuation of the target company. The premium paid can significantly impact the financial metrics of the acquisition and its overall cost.
Financial Reporting: Companies need to account for acquisition premiums in their financial statements, and they can have implications for goodwill and intangible asset recognition.
Challenges of Acquisition Premium
Overpayment Risk: Paying a substantial acquisition premium carries the risk of overpaying for the target company. If the expected benefits and synergies of the acquisition do not materialize as projected, it can result in financial losses for the acquiring company.
Dilution: For the acquiring company, paying a high premium can lead to the dilution of earnings per share and a reduction in overall financial performance, which may not be well-received by its shareholders.