Behind the Bid: How buyers model their price

You open the offer letter from a potential buyer. Your eyes dart past the preamble, looking for the number... what is their offer price?

The buyer does lots of work to get that offer price. They do due diligence, financial modelling and scenario planning – which all become key inputs into their valuation calculation.

But what are they really doing in this modelling process?

Understanding this from their perspective can be a key advantage in getting a higher price.

Let's break down their process, their actions at each stage, and what you can do to get a better price...

1) Understand your business

First, some context. We're in the early stages of the deal, what we call the Exploration phase.

They are not yet quantifying the value of their bid – but working out whether they want to bid or not.

They will review your historical financial statements and the Confidential Information Memorandum. Then ask you questions in management meetings and early due diligence requests.

They are looking to understand basic things like your business model, the state of the industry and the health of the business.

Of course they want to see a healthy, sustainable business in a growing market.

But they also want to see that you're a good fit with their strategy (see The SIX strategies that drive M&A) and that there's some potential synergy value too (see Synergies 101).

If you pass that test, they will start getting into the numbers.

2) Examine your forecasts

As part of the initial due diligence, they will ask you for financial forecasts. Those usually cover the next 3-5 years, mapping out how your revenues, costs and profits will change over time.

These numbers are very important, as they give a sense for how bullish you are for the future of the company.

There's also a second layer of insight – the forecasts will tell them your expectations on things like:

• Where will growth come from? What mix of customers, increased pricing, new products, new markets?
• Will growth rates slow down in later years?
• What will happen to gross margins?
• How will the team need to grow to support the growth? How much leverage is there?
• How much investment is needed in technology and infrastructure?

Building forecasts is stressful for many sellers. The process itself is daunting, and there's this great concern over how to balance bullishness with credibility.

If that resonates with you, check out two articles:

👉 How to build great financial forecasts for your buyer: We break down how to build out your forecasts, common pitfalls and some tips to impress your buyer

👉 The Goldilocks Problem: How to get your forecasts 'just right': Not too hold, not too cold... we share the 60% rule on how to push your growth forecasts without losing your credibility with a buyer.

Buyers then immediately start sense-checking these figures, poking holes and running analysis to get a sense of how believable and likely the forecast numbers. That's when they move into the next stage of their analysis.

3) Build out their own models

Your financial forecast forms the starting point for their analysis.

They take your model, and start making adjustments. That might be where they don't believe certain assumptions you have made, turning down certain growth levers where they think you've over-estimated, or adding in additional costs which have been missed.

They will also start to understand and quantify various scenarios. This helps them to quantify the extent of the upside or downside if those scenarios come about.

Here are some examples:

• Growth rates slows down in years 4 and 5 as you hit saturation in your market
• You lose a major customer who you rely on for 40% of revenue
• Customer churn rates increase from 8% to 12%
• Forecast price increases are not possible
• Launch of a new product is delayed by a year
• Input costs increase so gross margins reduce by 10%
• Customer acquisition costs increase 30% as you move into new segments
• Headcount forecasts are undercooked, and you need a 20% bigger team

This process is usually lead by the M&A team, with input from the sponsor and the finance team (see Who's on your buyer's team?).

These assumptions and scenarios are then tested through the initial DD process. You will get specific data requests and questions to management, targeted at a scenario or data point they are looking to explore and quantify.

For example, if they are modelling the impact of customer churn, they will ask for historical churn data broken down by customer segments. Or if a large amount of revenue growth comes from a new product, they will ask for your research on that opportunity.

In How to build great financial forecasts for your buyer, we recommend keeping detailed notes as you build the forecast, which walk through the model line by line, explaining your thought process at each stage and provides supporting data, cross-checks and justifications. This will help to answer their questions upfront, clearly and with data.

This data is used to adjust an input in their model, which then spits out different numbers for your financial performance.

This helps them understand what inputs your business is most sensitive too, which then guides further questions and due diligence.

4) Add in synergies

During this exercise, they will be evaluating the potential synergies from the deal too.

If you want to learn more about synergy, we have an overview with examples in Synergies 101, then in How to unlock synergy value with your buyers we explain how to work with your buyer to find, evaluate and quantify synergies

The buyer will take the potential synergies, with an estimate of the financial impact for each. This impact could be an uplift in sales, or a reduction in costs, both flowing through to improved EBITDA in your business, theirs, or both.

They usually then put a percentage likelihood on each of these to get to an aggregate expectation-adjusted value for the synergies.

This data is added into their financial model, as additional levers to increase revenue or decrease costs.

5) Convert to valuation

The end product from all of this work is a menu of scenarios – variations on your original forecasts which range from bullish to bearish, with an expected financial performance for each.

These numbers are then the key input into their valuation calculations.

Most commonly, a buyer will get to a valuation by taking your most recent financial performance, and applying a multiple to that to get to a price.

And this is where this financial modelling comes in...

From all of this analysis, they will have a confidence level on the future performance of the business. If their modelling shows strong growth forecasts, with well-supported assumptions and lots of synergies, they can afford to pay a much higher valuation multiple.

This is how this modelling exercise turns into a number that drops into your offer letter.

If they are more confident, they can pay more whilst still keeping a decent margin of safety. Conversely, if their scenarios show that growth could slow down or that costs could easily rise, they will only feel able to pay a much smaller valuation multiple.

There are other factors of course – how desperately they need to make an acquisition to fulfil their goals, how many other bidders are interested (see here) and how hot the market is.

But getting them excited and confident about the future of the business is the biggest lever to a higher price.

The buyer might also use the same forecasts to run a discount cash flow analysis to sense check their offer. And they will triangulate the valuation against public benchmarks, and other similar deals they've done before.

If you are new to valuation and multiples, check out our collection of articles on valuation here.

6) Present findings

Finally, this analysis is wrapped up into an internal presentation to the CEO, or the Investment Committee if they have one.

In that presentation, they will explain the prospects for the business and the learnings from the due diligence done so far. That will include an explanations of the forecasts, the various scenarios modelled and the financial outcomes in each.

Their report will then say, for example:

Once that's approved, that's the number that goes into your offer letter or LOI.

How to maximise your offer

Armed with this knowledge, what can you do get this number as high as possible?

• Set bullish but credible forecasts. Follow the 60% rule to make sure you setting ambitious and exciting growth targets which are also defensible.
• Get your data ready in advance, so you can get it over to them quickly. Your financial model should be tidy and easy to read, and come with supporting charts and commentary.
• Make sure your numbers are well supported. There's nothing more alarming than a seller who doesn't know their numbers, and looks like they are making them up on the spot.
• Work in collaboration with the buyer. M&A is a team sport and a collaborative process, not a fight. You need to work together with your buyer to get a deal done that works for both of you. In this situation, you should be thinking: "What can I share to help you validate our growth forecasts?"
• Be honest. No business is perfect, and a seller who claims that their business is flawless with a perfect track record isn't credible. Celebrate your best points, and be direct about what issues need work (and explain how you will fix them).

A lot of the advice here applies generally to the acquisition process. A seller who is organised, knows their numbers and has the right attitude will get a much higher price.

Good luck!