Acquisition Premium

The difference between the price paid for the firm being purchased and the current market value of the firm

Author: Christopher Haynes
Christopher Haynes
Christopher Haynes
Asset Management | Investment Banking

Chris currently works as an investment associate with Ascension Ventures, a strategic healthcare venture fund that invests on behalf of thirteen of the nation's leading health systems with $88 billion in combined operating revenue. Previously, Chris served as an investment analyst with New Holland Capital, a hedge fund-of-funds asset management firm with $20 billion under management, and as an investment banking analyst in SunTrust Robinson Humphrey's Financial Sponsor Group.

Chris graduated Magna Cum Laude from the University of Florida with a Bachelor of Arts in Economics and earned a Master of Finance (MSF) from the Olin School of Business at Washington University in St. Louis.

Reviewed By: Austin Anderson
Austin Anderson
Austin Anderson
Consulting | Data Analysis

Austin has been working with Ernst & Young for over four years, starting as a senior consultant before being promoted to a manager. At EY, he focuses on strategy, process and operations improvement, and business transformation consulting services focused on health provider, payer, and public health organizations. Austin specializes in the health industry but supports clients across multiple industries.

Austin has a Bachelor of Science in Engineering and a Masters of Business Administration in Strategy, Management and Organization, both from the University of Michigan.

Last Updated:September 20, 2023

What Is Acquisition Premium?

In mergers and acquisitions (M&A), the difference between the price paid for the firm being purchased, i.e., the target firm, and the assessed market value of that firm is known as the acquisition premium.

In other words, the acquisition premium, also known as the takeover premium, is the extra amount paid by an acquiring company, i.e., the acquirer, in addition to the estimated real value of all identifiable assets of the target company.

In financial accounting, the acquisition premium is called goodwill, which is recorded as an intangible asset on the acquirer's balance sheet after the transaction.

Opposite a tangible asset such as equipment and factories, an intangible asset is referred to as an identified item with no physical substance. Brand name and intellectual property (IP) like trademarks and copyrights are examples of intangible assets.

In terms of calculation of goodwill in accounting, it equals the value that exceeds the target company's assets minus its liabilities:

Goodwill = P - (A - L)


  • P = Purchase price of the target company
  • A = Fair market value of the target company's assets
  • L = Fair market value of the target company's liabilities

Note that the core idea of goodwill and acquisition premium is the same. However, we use different formulas to calculate them solely because these two words are referred to and used by professionals in different business realms (you will learn how to calculate the premium in the section below). 

It is worth noting that a firm is not required to pay a premium when purchasing another company; depending on the circumstances, the acquiring company may even receive a discount on the final deal price.

In 2016, the acquisition of LinkedIn, the world's biggest professional network, by Microsoft, one of the world's largest tech companies, took place. 

Microsoft paid $196 per share, including a 50% takeover premium on LinkedIn's share price, since they anticipated the deal would positively impact Microsoft's revenue and competitive position.

Key Takeaways

  • In a merger or an acquisition, the difference between the price paid for a target firm and the assessed market value of that firm is known as the acquisition premium.
  • The acquisition premium is also known as the 'takeover premium' or 'goodwill.'
  • There are two ways to calculate the acquisition premium using either the enterprise value or equity valuation. Despite the differences in the formulas, the two methods share the same logic: the acquirer must determine the true value of the target business first.

Reasons for Acquisition Premium

The fact that an acquiring company is willing to pay a higher price than the market value of the target company may not make sense intuitively.

It is worth noting, however, that the target company's current pricing reflects what it is worth in the eyes of the market. On the other hand, an acquirer may place a higher value on the target company than the market, owing to the strategic value the target company may provide.

The following are the reasons explaining why an acquiring company pays a premium:

1. Expected Synergy

The most common reason for a merger or an acquisition is the generation of synergies, in which the combined value of two enterprises is greater than the sum of their individual parts.

In general, there are two forms of synergies — hard synergies and soft synergies. Soft synergies indicate revenue hikes via improved market share, cross-selling, and increased pricing power, while hard synergies refer to cost reductions from economies of scale.

When the acquirer expects a high potential financial benefit from a deal, they will be willing to pay more premium.

2. Stronger Position in the Market

When an industry is more consolidated, businesses in that industry may have fewer rivals.

A merger or an acquisition offers the consolidated firm a stronger position in the market, allowing it to manage more areas of the supply chain, minimizing dependency on third parties.

When two firms join together, their combined operations and customer base provide the merged entity with a stronger position in the market. Hence, the acquirer may pay a premium in exchange for a stronger position in the market.

3. Increased International Presence

A merger or an acquisition can be used as a strategic instrument to expand a company's international market reach.

Less regulation and more consistent accounting standards in the international market will make a deal a more prevalent basis for future M&A deals for the acquirer, who consequently might be willing to pay a premium to secure the target company.

4. Diversified Portfolio

From a company's perspective, diversification can be viewed as a portfolio of investments in other companies.

Diversifying a company's cash flows into different industries through M&A transactions can mitigate the cash flow fluctuation for the acquiring company. As a result, the acquiring company might pay extra to join the target firm.

5. Competitive Advantage

An acquirer may seek competitive advantages or secure resources that it now lacks from the target firm through a merger or an acquisition.

Specific competencies or resources, like a strong research and development (R&D) team, a profit-generating sales staff, or other distinctive talents, are examples of competitive advantages or unique resources.

These advantages and resources may encourage the acquiring company to pay more.

6. Outbidding Other Bidders

Sometimes, the target company is very desirable. For instance, Facebook had to compete with Twitter on its offer before acquiring Instagram for $1 billion in cash and stock.

Twitter allegedly offered $525 million to Instagram as the company felt that Instagram's product nicely aligned with Twitter's business, and the company had been planning to have more presence in the media space.  

To block the Twitter deal, Mark Zuckerberg paid what at the time seemed like an astounding sum of $1 billion for the photo-sharing start-up, which had only 13 employees at the time. 

However, in less than ten years, Instagram has emerged as a crucial pillar of Facebook's expansion. As a result, if there are other bidders for the target company, the acquirer may need to pay a significant premium to outbid them.

7. Tax Reduction

In some circumstances, it may be favorable for an acquirer to purchase or merge with a company that has substantial tax losses so that the acquirer may rightfully reduce its tax obligation.

Suppose the perceived value of any of the aforementioned reasons is greater than the market value of the target company. In that case, the acquirer may be encouraged to participate in an M&A transaction to buy the target company with an extra takeover premium.

How to Calculate Acquisition Premium?

To calculate the acquisition premium, the acquirer must determine the true value of the target business, which can be calculated by using either the enterprise value or equity valuation.

Calculating the premium using the target company's share price:

  1. Calculating the difference between the price paid per share for the target firm in the current deal and the target's current stock price: (DP -SP)
  2. Dividing the difference (DP - SP) by the target's current stock price to get a percentage amount:

AP = (DP – SP)/ SP * 100


  • AP = Acquisition/Takeover Premium
  • DP = Deal Price per share of the target company
  • SP = Current Share Price of the target company


Calculating the premium using the enterprise value:

Calculating the difference between the price paid by the acquiring company and the pre-merger value of the target company.

AP = PT - VT


  • AP = Acquisition/Takeover Premium
  • PT = price paid for the target company in the current deal
  • VT = Pre-merger value of the company

Examples of Acquisition Premium

Let us understand the concept by looking at a few examples below:

Example 1: Take the example of LVMH's acquisition of Tiffany & Co., in which the Paris-based luxury goods conglomerate, LVMH, acquired the American jeweler Tiffany & Co. for $15.8 billion or $131.5 per share in January 2021.

At the time of the initial announcement of the acquisition in October 2019, the deal was supposed to be $16.2 billion ($135 per share), and Tiffany's stock price was around $92.7 per share.

With the official announcement of the deal, the stock price of Tiffany jumped by 6.2% to $98.5 per share approximately. However, the deal was renegotiated due to Covid-19 and Tiffany's poor performance, and the final price of $15.8 billion was signed in January 2021.

Assuming the stock price is $98.5 per share, we can calculate the acquisition premium LVMH paid.

According to the formula, the acquisition premium is:

AP = (DP – SP)/ SP * 100

AP when the deal was $16.2 billion or $135 per share:

AP = (135 – 98.5)/ 98.5 * 100

AP1 = 37% per share

AP of the final deal of $15.8 billion or $131.50 per share:

AP = (131.5 – 98.5)/ 98.5 * 100

AP2 = 33.5% per share

Example 2: For the method using the enterprise value, let us take a hypothetical merger of two companies, X Co. and Y Ltd. The enterprise value of Y Ltd. is $12.5 million, and X Co. is offering a 15% premium.

Price Paid for Y Ltd:

PT = $12.5 million + 15% of $12.5 million

PT = 12.5 * 115/100 = $14.375 million

Pre-merger Value of Y Ltd (VT) = $12.5 million

According to the formula, 

AP = PT - VT

AP = $14.375 million - $12.5 million = $1.875 million

Researched and authored by Aqsa Wasif | LinkedIn

Reviewed and edited by Hongmo Liu | LinkedIn

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