What is Control Premium?
Control Premium is the additional consideration the buyer of shares willing to pay over and above the market price of the shares in order gain majority stake in the company. Small quantity of shares can be traded in secondary market, but to acquire larger interest in the company the buyer has to offer additional price than the market price so that the existing shareholders would show interest in selling the shares.
A buyer who pays control premium would be able to acquire a large sum of shares and by which the acquirer firm can control and monitor the activities of the business and would be part of the key decisions taken by the company. It is paid when there is potential benefit from the acquiring company, and the merger will bring in synergy and more benefits. It is paid more when there is a competition in acquiring the firm.
Formula
Examples
Example #1
X Corp wants to acquire ABC Inc. The value of per share of ABC Inc. is $15, but X Corp offers a price of $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 and based on the industry line. The premium is decided on the value and benefits that can be derived from the acquisition; it also depends on the competition present in the acquisition. The premium is decided based on what share price is 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.
Solution
Z Group believes that if SM Corp is merged with Z Group, then there would be more business opportunities, and there would be synergy, and it brings more gain to the business. Post-acquisition Z Group estimates that the value of SM Corp may increase to $12,000,000. The additional benefit that can be derived by acquisition is $4,000,000.
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To take over SM Corp, 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 acquisitions. Control premium can range from 20% – 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 intrinsic value of the company, additional value or the synergy that can be derived by acquiring the target company.
The control premium is unnecessary if the target company cannot maximize the value post-acquisition. Size of the premium can be influenced by various factors like possible maximization of value post-acquisition, any other rival firm/competitors trying to acquire the same target firm or what is the expectation of the existing shareholders to give up their stake in the company.
By acquiring 51% stake in the target company by paying the control premium, they have major power in directing the business activities, and they can be part of all decision making; If they acquire 26% or more, they can exercise significant influence in directing the activities.
It varies according to the business line and industry. It also depends at the time period of acquisition, market and economic conditions.
It can be paid using cash or in the form of shares of the acquiring company or the combination of both. This is decided based on the needs and expectation of the acquiring firm as well as the existing shareholders.
Reasons
The control premium is paid to acquire majority shares in the company. Majority shareholder can influence the decisions and the operations of the company. It helps to close the deal before it becomes more competitive, and it is also 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 dividends.
- Approval of budgets, and the expenditure for the business.
- Deciding the strategy and long-term plans of the business.
- Decision making in business operations.
- Managing all assets transactions.
- Freedom to change the policies and operational aspects of the business.
- Restructuring, liquidating or merging the company.
Advantages
- Control premium enables to acquire 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 in acquiring the controlling interest in the business and can exercise significant control over the operations of the business.
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