What is a Control Premium?

ByMunyaradzi Mafaro

A control premium is the extra money a company pays to buy another company. They pay this because they want to be the boss of the other company. How much extra they pay depends on how good the other company’s bosses are at their job.

Why Companies Pay a Control Premium

Companies pay a control premium when they really want to own another company. Owning the company lets them make all the decisions. They can fire the old bosses and hire new ones. They can change how the company does things.

The extra money is like a bonus for getting to be in charge. But it’s a backwards bonus. If the old bosses were doing a great job, the company won’t pay as much extra. That’s because the company is already doing well. There’s not as much room for the new owners to make it better.

But if the old bosses weren’t so great at running things, the new company might pay a big control premium. They see a chance to make the company a lot better once they’re the boss. The worse the old bosses were, the more the new company will pay to get rid of them.

How Much is a Control Premium?

The size of the control premium depends on a few things:

  • How big is the company being bought?
  • How well is the company doing?
  • How much do the new owners think they can improve things?

For a big company that’s doing okay, the premium might be pretty small, like 10-20% extra. But for a smaller company that’s having problems, the premium could be 50% or more on top of the regular price!

Examples of Control Premiums

Let’s look at a made-up example to see how this works. Pretend there are two lemonade stands: Liz’s Lemons and Derek’s Drinks. Liz’s stand makes $10 a day and Derek’s makes $20.

Liz’s Lemons

Liz is pretty lazy with her stand. She uses old lemons and too much sugar. She only works a few hours a day. An investor wants to buy her out for $100.

But he thinks if he took over, he could make the stand way better. Buy fresh lemons, use the right recipe, stay open longer. So instead of $100, he offers Liz $150. That extra $50 is the control premium. It’s a lot extra—50%! That’s because Liz was doing such a bad job that the new owner sees a big chance to make more money.

Derek’s Drinks

Now Derek, he runs a top notch lemonade stand. He already buys the best lemons and his ratio of sugar to lemon is perfect. Plus he’s open all day, every day. The same investor wants to buy Derek’s stand too.

Derek’s stand makes twice as much as Liz’s, so the investor offers him $200. But he only offers a little more, like $220 total. The control premium for Derek’s stand is much smaller, only 10% extra.

That’s because Derek’s stand is already doing great. The new owner can’t improve things very much. So it’s not worth paying a big premium to get control.

Munyaradzi Mafaro is a music enthusiast and he also likes to tackle topics of business, productivity, and the possibilities for growth in the digital world.

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