Control Premium

Posted in Finance, Accounting and Economics Terms, Total Reads: 554
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Definition: Control Premium

It is an excess amount the buyer is willing to pay over the current value of the publicly traded company to acquire control of it. It is the calculated as the difference between purchased price and current market price of the company. The company pays premium when company expects synergies between two companies after acquisition.

Generally the control premium varies across the firms and industries. There is no rule of thumb that applies across all the firms. It is also known as acquisition premium. Generally, control premium is 20–50% of the market capitalization of a company calculated based on a 20-trading-day average of its stock price.

When company decides to pay premium?

The premium amount is arrived at estimating the value of expected cash-flows and changes in the company management after acquisition is made. Company can decide to pay premium when it thinks that target Company is poorly managed and it can add value by replacing current management or by lowering their compensation.

Factors determining premium:

1)      Performance of the management of the target firm

2)      Ease of making marketing decisions – the feasibility of making quick decisions, implementing them and generating early cash flows

3)      External factors that affects company’s performance- If the external factors has led to company’s poor performance premium may not be as high as otherwise

Example:

Company A has 1,000,000 shares in the market. The 20-day average price per share is $1. Let’s say, the buyer wants to acquire 80% of the stock which will give him the control of the company. The market price will be 800,000 * $1.00 = $800,000. However, the buyer estimates that he will be able to realize 10%-synergy, so the maximum price he is willing to pay is $800,000 * (1 + 10%) = $880,000 Here, $ 80000 is the control premium paid by buyer A.

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