What is Control Premium?

A buyer who pays a control premium would acquire many shares. The acquirer firm can control and monitor the activities of the business and would be part of the key decisions taken by the company and paid when there is potential benefit from the acquiring company. The mergerMergerMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more will bring in synergySynergySynergy in M&A is the approach of business units that if they combine their businesses by forming one single unit and then working together to achieve a common goal, the total earnings of the business can be greater than the sum of the earnings of both businesses earned separately, and the cost of the merger can be reduced.read more and more benefits. It produces more when there is competition in acquiring the firm.

Formula

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Control Premium = Acquisition / Take Over Price (-) Market / Estimated Price

Examples

Example #1

X Corp. wants to acquire ABC Inc. The value per share of ABC Inc. is $15, but X Corp. offers $20. The control premium X Corp. willing to pay is $5 per share (i.e.) 30% premium [($20-$15)/ $15].

Solution

Control premium varies from business to business, depending on the industry and the value and benefits derived from the acquisition. In addition, it also depends on the competition present in the acquisitionAcquisitionAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more. Finally, the premium is determined based on the share price considered for acquisition.

Example #2

Z Group wants to acquire SM Corp. The valuation of the business of SM Corp. comes to $8,000,000.

Z Group believes that if SM Corp. merges with Z Group, there will be more business opportunities and synergy, bringing more gain to the business. In addition, post-acquisition Z Group estimates that the value of SM Corp. may increase to $12,000,000. Therefore, the additional benefit derived by acquisition is $4,000,000.

Z Group decides to pay a premium to acquire the shares. It has decided to $2,000,000 as an acquisition premium (i.e.) 25% premium. Total takeover value is $10,000,000.

Range of Control Premiums

The control premium is a major consideration in mergers and acquisitionsMergers And AcquisitionsMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more. Control premium can range from 20% to 80%; it purely depends on the business condition of the acquiring firm and market demand for the same. It shall be determined based on the company’s intrinsic valueCompany’s Intrinsic ValueIntrinsic value is defined as the net present value of all future free cash flows to equity (FCFE) generated by a company over the course of its existence. It reflects the true value of the company that underlies the stock, i.e. the amount of money that might be received if the company and all of its assets were sold today.read more, additional value, or the synergy one can derive from acquiring the target company.

The control premium is unnecessary if the target company cannot maximize the value post-acquisition. The premium’s size may influence by various factors like possible maximization of value post-acquisition, any other rival firm/competitors trying to acquire the same target firm, or the expectation of the existing shareholders to give up their stake in the company.

It varies according to the business line and industry. It also depends on the period of acquisition and market and economic conditions.

One may pay using cash or in the form of shares of the acquiring company or a combination of both. It is decided based on the needs and expectations of the acquiring firm and the existing shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more.

Reasons

The control premium is required to pay to acquire majority shares in the company. The majority shareholderMajority ShareholderA majority shareholder or controlling shareholder is an individual or a corporation that owns the majority of the company’s stock (more than 50%) and therefore enjoys more voting power than other shareholders. These shareholders are in a position to influence the company’s decisions.read more can influence the decisions and the operations of the company. It helps close the deal before it becomes more competitive, and the synergy and the benefits derived from the acquisition will be greater than the price paid for the acquisition. The premium is paid only to derive the additional benefits by gaining full control over the business using acquisition. Some of the major decisions that the majority shareholder can decide upon are: –

  • Appointment of management.Fixing the compensation for the managerial personnel.Declaration of dividendsDeclaration Of DividendsDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities.read more.Approval of budgets and expenditures for the business.Deciding the strategy and long-term plans of the business.Decision-making in business operations Business OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company’s goals like profit generation.read more.Managing all assets transactions.Freedom to change the policies and operational aspects of the business.RestructuringRestructuringRestructuring is defined as actions an organization takes when facing difficulties due to wrong management decisions or changes in demographic conditions. Therefore, tries to align its business with the current profitable trend by a) restructuring its finances by debt issuance/closures, issuance of new equities, selling assets, or b) organizational restructuring, which includes shifting locations, layoffs, etc.read more, liquidatingLiquidatingLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more, or merging the company.

Advantages

  • Control premium enables the acquisition of shares from existing shareholders as the price offered for the shares is more than the market price.It helps to complete the acquisition before more competitors enter the deal.It helps acquire the controlling interestControlling InterestA controlling interest is the shareholder’s power to speak in the corporate actions or decisions derived from possessing a considerable chunk of the company’s voting stock. However, such a stakeholder may or may not hold a significant portion of the company’s common stocks.read more in the business and can exercise significant control over its operations.

This article is a guide to Control Premium and its definition. Here we discuss the control premium formula, examples, and reasons for paying such a premium. You can learn more about it from the following articles: –

  • Reverse TakeoverTakeover BidAcquisition PremiumHostile Takeover