Don't succumb to the seller's curse.

• Author: Rizzi, Joe
• Position: COMPETITIVE EDGE

A question for boards: Has your company reached its sell-by date? If so, are you prepared to let go?

The buyer-related Winner's Curse is well known. It involves overpaying for targets relative to the benefits received. Essentially, the buyer commits a classic error of commission. Although less discussed, the Seller's Curse is equally dangerous. It occurs when sellers overvalue themselves and reject an offer they should have accepted --a colossal error of omission.

Both curses are based on overoptimism. For buyers, they believe they can obtain needed improvements in the target to justify the price. For sellers, they believe that future returns justify forgoing a current offer.

Firms go through life cycles. The best owner of a business changes for each stage of the cycle. As firms age, they--like cottage cheese--reach a sell-by date. New owners can extract more value through better execution of higher-valued strategies. This is important in rapidly evolving industries like big pharma where value chains are changing, making current asset combinations obsolete.

Current owners find this fact hard to accept due to emotional ties to their organizations. These ties are difficult to overcome unless you have a disciplined process to determine if you have reached your sell-by date. This requires comparing retained value from not selling with your private market price in the M&A market.

Retained value, the floor or refusal price below which the firm should not be sold, is similar to the reservation or maximum price a buyer can offer without diminishing its own shareholder value. The retained value is the potential seller's expected cash flows discounted at its cost of capital. Private market value is based on recent comparable transactions.

If the private market value is greater than the retained value, then the firm is worth more to someone else than to the current owners. M&A is based on differences between actual and potential value. There is no one true value. It depends on the owner-management team's chosen strategy and execution ability. Sellers can capture the upside of selling to a higher-valued owner through the buyer's bid premium. Even if you elect not to sell, you at least know the opportunity cost of that decision.

Seller's reluctance to...