How Scarcity Value Affects M&A Valuations of Target Companies | CapEQ

In the world of M&A, one key concept that can significantly drive the valuation of a target company is scarcity value. When a company possesses unique or hard-to-replicate assets — whether that’s intellectual property, market position, or specialised expertise — acquirers often pay a premium for businesses that offer something rare or difficult to find elsewhere.

In this blog, we’ll explore what scarcity value is, how it affects M&A valuations, and why it’s particularly important for both acquirers and sellers to understand its impact.

What is Scarcity Value in M&A?

Scarcity value refers to the additional value that a target company holds due to its unique, rare, or hard-to-replace assets or market position. This value is typically driven by the principle of supply and demand—if a company has something that is scarce or in limited supply, it becomes more attractive to potential buyers, often leading to a bidding war that pushes up its valuation.

Scarcity value can arise from a number of factors, including:

• Proprietary technology or intellectual property (IP) that competitors don’t have.
• Dominant market share in a niche industry or geographic region.
• Exclusive contracts or partnerships that are difficult for others to secure.
• Specialised talent or expertise that is rare within the industry.
• Unique customer base that is loyal and hard to replicate.

These factors create an environment where acquirers feel compelled to pay a premium because the asset is either critical to their strategy or simply cannot be easily substituted.

How Scarcity Value Affects M&A Valuations

Scarcity value influences M&A valuations in several ways, often increasing the final price tag beyond what standard valuation formulas predict. Here’s how:

Higher Premiums Due to Competitive Bidding

In many M&A deals, particularly those involving companies with scarce assets, multiple buyers may be interested, leading to a competitive bidding process and auction conditions. As acquirers recognise the rarity of the target’s assets, they may be willing to pay a higher price to outbid competitors and secure the deal. The result is often a valuation premium that far exceeds the company’s intrinsic value based on financials alone.

For example, in tech M&A, companies with scarce intellectual property (such as innovative software or patents) often attract significant attention from multiple buyers, pushing up their valuation considerably.

PRO TIP: Take time to really understand the value of IP in your business – including licences, domain names, copyrights and databases – to make better decisions about where to invest further, to prioritise R&D work, and which technologies or brands to develop.

Strategic Value for Acquirers

Scarcity value can also arise when the target company fills a critical strategic gap for the acquirer, such as gaining access to a new market, acquiring rare talent, or obtaining exclusive distribution rights. In these cases, the acquirer may view the deal as essential to achieving their long-term goals, leading to a higher willingness to pay.

For instance, if a global tech firm seeks to enter a specific geographic market where only one company has established strong local relationships and infrastructure, the target company’s scarcity in that market will significantly boost its valuation. The acquirer is not just buying a business but also securing a foothold in a crucial market that would be hard to replicate through organic growth.

Control Premiums

Scarcity value often leads to control premiums in M&A deals. A control premium is the additional amount an acquirer is willing to pay over the market value of a company’s shares to gain control. When a target company holds scarce assets that give it competitive advantage, the control premium reflects the buyer’s desire to seize control and leverage those rare assets for strategic gain.

For example, a pharmaceutical company that owns patents for a breakthrough drug might command a large control premium, as the acquirer seeks to control and monetise the intellectual property that few, if any, competitors possess.

Examples of Scarcity Value in M&A

Many high-profile M&A deals have been driven by scarcity value, illustrating how unique assets can drastically influence valuation. Here are a couple of examples:

• Facebook’s Acquisition of Instagram (2012): Instagram had a relatively small user base at the time of acquisition but was seen as a scarce asset due to its growing popularity and unique position in the social media landscape. With few competitors offering a similar mobile photo-sharing platform, Facebook recognised the scarcity value and acquired Instagram for $1 billion — far more than its financial performance would have justified at the time. Today, Instagram is one of Facebook’s most valuable assets.
• Google’s Acquisition of DeepMind (2014): Google purchased DeepMind for $500 million, largely due to the scarcity of its advanced artificial intelligence (AI) capabilities. At the time, DeepMind was a leader in cutting-edge AI research, an area in which few other companies had such specialised expertise. The scarcity of this knowledge and talent drove the premium Google was willing to pay, reflecting the strategic importance of AI to Google’s future innovation.

Why Scarcity Value is Important for Sellers

For sellers, understanding scarcity value is crucial because it can significantly boost the business sale price. At SME level, identifying and highlighting your business’s unique assets or market position during the sale process can help attract more bidders and justify a premium valuation.

Key steps for founders and shareholdes to maximise scarcity value include:

• Identify Unique Assets: Determine what makes your company scarce in the marketplace. This could be proprietary technology, customer relationships, or expertise in a niche field.
• Highlight Market Position: Emphasise your company’s dominance in a particular market, whether geographic or industry-specific. If competitors can’t easily replicate your success, your company’s value will rise.
• Protect Intellectual Property: If your business relies on IP, ensuring that patents, trademarks, and copyrights are well-protected can increase scarcity value by making it harder for others to copy your innovations. Work with a reputable law firm’s IP team to build and protect a defensible position.
• Build a Loyal Customer Base: A loyal, hard-to-replicate customer base can be a significant asset, particularly in industries where customer acquisition costs are high or switching costs are low.

Why Scarcity Value is Important for Acquirers

For acquirers, scarcity value can justify paying a premium, but it’s essential to conduct thorough due diligence to ensure that the perceived scarcity is real and sustainable. Acquirers should:

• Evaluate the Strategic Fit: Does the target fill a crucial gap in your business or provide access to a market or asset that’s difficult to replicate? If so, scarcity value might justify a higher price.
• Assess the Longevity of Scarce Assets: Consider whether the M&A target’s scarce assets, such as technology or market dominance, are likely to retain their value over time. If the asset’s advantage is short-lived – for example a supermarket listing which could be cancelled – paying a large premium may not be worth the investment.
• Be Wary of Overpaying: While scarcity value can drive higher M&A valuations, it’s crucial to ensure that the premium paid is aligned with the target’s long-term strategic and financial benefits. Bidding wars can sometimes lead to overpaying, resulting in challenges for realising expected returns post-acquisition. Read how synergies affect valuations for more.

Conclusion

Scarcity value is a powerful factor in M&A valuations, often leading acquirers to pay a premium for companies that offer unique assets, expertise, or market positions that are hard to find elsewhere. Whether you are a seller looking to maximise the value of your business or an acquirer seeking to justify a premium, understanding the role of scarcity is essential.

Sellers should focus on highlighting their scarce assets and market positions to attract the highest possible price. Acquirers, on the other hand, must assess whether the scarcity value justifies the premium paid and ensure that the unique advantages offered by the target company align with their strategic goals.

By carefully considering scarcity value – preferably with expertise from a good M&A advisor – both buyers and sellers can make more informed decisions and maximise the benefits of their M&A transactions.