Definition - What does Valuation Gap mean?
A valuation gap is the difference in the actual market value of a company and the value that the owner expects to sell it for to achieve his/her needs. Valuation gaps are a common reason that many mid-market transactions fail to close.
Divestopedia explains Valuation Gap
The valuation gap has significantly widened in the past few years given:
- the failure of companies to generate adequate returns to cover their real cost of capital; and
- the increase in the expected or needed value by sellers because of the poor returns on substitute (or more traditional) investments.
Buyers and sellers often try to bridge the valuation gap during the sales process with mechanisms such as earnouts, vendor financing and/or rolled equity structures.
In our opinion, the best way to close a valuation gap is to develop a deep understanding of your company's value well before the sale. This will allow enough time for the business owner to implement value creation strategies to build a company's value that meets expectations. It can also eliminate the need to structure mechanisms that reduce the amount of cash received at closing.