What is a Bargain Purchase?
A bargain purchase occurs when a firm is purchased at a lower valueValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These methods of valuation are used in investment banking, equity research, private equity, corporate development, mergers & acquisitions, leveraged buyouts and finance than its fair market value. In this kind of transaction, businesses are sold mainly due to a crisis. There are other cases when a bargain purchase transaction occurs, such as in the case of a very rapid sale. In order for an acquirer to get a bargain purchase, the following steps have to be followed.
The first step is to record the assets and liabilitiesBalance SheetThe balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity along with their fair values. The next step is to assess whether all of the assets and liabilities have been properly recorded. If there are other considerations that need to be paid to the owners, they also have to be recorded. If there is any difference between the consideration paid and the fair value, that has to be recorded.
How does this work? For example, business owners of ATC have to sell their business even if the price is far below market value. ATC will then be sold to BTS Industries for $6,000. The acquirer then hires a firm that will analyze and evaluate all of the assets and liabilities. After conducting the analysis, the firm has concluded that the fair valueEnterprise ValueEnterprise Value, or Firm Value, is the entire value of a firm equal to its equity value, plus net debt, plus any minority interest, used in valuation. It looks at the entire market value rather than just the equity value, so all ownership interests and asset claims from both debt and equity are included. of ATC’s net assets is $9,000. By subtracting the difference, you get the gain or the bargain purchase.
The Aftermath of the 2008 Market Crash
After the market crash in 2008, there were a lot of firms that were bought at far lower than their market value. Other, more financially stable firms were able to take advantage of buying these companies.
Though there were limited amounts of bargain purchases, acquirers were able to take advantage of low bargaining power. This was brought about by unfavorable circumstancesDistressed DebtDistressed debt refers to the securities of a government or company which has either defaulted, is under bankruptcy protection, or is in financial distress and moving toward the aforementioned situations in the near future. It includes all credit instruments that are trading at a significant discount that beset the firms in question.
Read more about other types of purchases
To learn more, see the following free CFI resources:
- Asset DealAsset DealAn asset deal occurs when a buyer is interested in purchasing the operating assets of a business instead of stock shares. It is a type of M&A transaction. In terms of legalese, an asset deal is any transfer of a business that is not in the form of a share acquisition.
- Stock DealStock AcquisitionIn a stock acquisition, the individual shareholder(s) sell their interest in the company to a buyer. With a stock sale, the buyer is assuming ownership of both assets and liabilities – including potential liabilities from past actions of the business. The buyer is merely stepping into the shoes of the previous owner
- Asset vs Stock DealAsset Purchase vs Stock PurchaseAsset purchase vs stock purchase - two ways of buying out a company, and each method benefits the buyer and seller in different ways. This detailed guide explores and lists the pros, cons, as well as reasons for structuring either an asset deal or a stock deal in an M&A transaction.
- M&A ProcessMergers Acquisitions M&A ProcessThis guide takes you through all the steps in the M&A process. Learn how mergers and acquisitions and deals are completed. In this guide, we'll outline the acquisition process from start to finish, the various types of acquirers (strategic vs. financial buys), the importance of synergies, and transaction costs
