Valuation for Mergers, Buyouts, and Restructuring, Second Edition

Chapter 10

Deal Making with Difference of Opinion

10.1 SOURCES OF DISAGREEMENT IN DEAL MAKING

In an acquisition, the parties exchange cash flows. In a cash-purchase, the acquirer exchanges a certain, measurable amount of value for expected future cash flows. In a merger effected through an exchange of shares, the seller receives claims to the joint cash flows of the merged company and surrenders claims to the target's cash flows. Finance practitioners refer to these exchanges as deals. In fact, one can define a deal as an agreement among parties for the exchange of cash flows.

A deal distributes cash flows among the parties participating in the transaction by amount, time, and risk. A deal depends on the parties' appraisal of the values being exchanged.

In general, a deal can take place only if there is a difference of opinion among the parties about the value being exchanged, because both have to believe that the transaction makes them better off. The difference of opinion about value arises from different appreciation about its determinants. As Sahlman (1988) noted:

1. Because cash flows are uncertain and difficult to estimate and the discount rates to apply for valuing them are not precisely known, the parties may disagree about expected cash flows, their risks, and the appropriate discount rates to use.
2. The parties to a deal may be affected differently by the transaction because of wealth, portfolio composition, or tax exposure.
3. The parties would normally have different information ...