Why does a buyer offer to pay more for a target than the price at which the target’s shares currently trade? One reason is certainly to keep other potential bidders from entering the fray with their own bids. However, the real reason is that shares trade based on their value to individual shareholders, who have no control over the business; thus, a share price is only based on the prospective financial return that a shareholder expects to achieve. However, if a buyer wishes to obtain control over the target, then it should expect to pay a control premium over the current stock price. By doing so, it has complete control over the potential size and timing of cash flows. Historically, this has made the control premium worth somewhere in the range of 35 – 50% of a target’s freely traded stock value. Recent control premiums for the purchase of publicly traded companies can be found in the annual Control Premium Study that is published by Mergerstat (located at www.mergerstat.com).
The Control Premium