Precedent Transaction Analysis: A Valuation Approach

Precedent Transactions Analysis is a method of company valuation where past Mergers & Acquisitions transactions are used to estimate a company’s value by comparing the prices paid for similar companies in the past.

1. 1. Identifying Comparable Transactions

      Industry: The target company must be in the same or a closely related industry as the companies involved in the transactions you’re comparing.
      Size: Revenue, EBITDA, assets, or other financial metrics should be comparable.
      Geography: Intra-regional or intra-national exchanges are preferred because market conditions, regulations, and economic environments are different.
      Time: More recent transactions are preferable since market conditions continually change.

   2. Gather Transaction Data
      

      Deal Value: Amount paid for the acquirer in each deal.
      Deal Type: All cash, stock-for-stock, or both
      Multiples Paid: Critical financial multiples are calculated for every deal, including but not limited to
      EV/EBITDA Enterprise Value/EBITDA: One of the most common multiples and can be used to illustrate what acquirers are willing to pay relative to earnings before interest, taxes, depreciation, and amortization.
      Enterprise Value/Revenue (EV/Revenue): More useful when EBITDA is negative or not relevant.
      Price/Earnings (P/E): Especially relevant in cases of public company transactions but less common in the case of private companies.

   3. Adjust for Deal-Specific Factors

      There can be some transactions with synergies, special strategic rationales, or distressed sales that alter multiples. Such details may call for an adjustment to compare better.

   4. Analyze your valuation multiples
      

      Using data obtained from several precedent transactions, determine the range of multiples paid-for example, low, median, high. These multiples will be used as a starting point for value estimation.
      Focus on the most relevant multiple for the specific industry, for example, EV/EBITDA for a service-oriented company and EV/revenue for an early-stage technology company.

   5. Use the Multiples on the Target
      

      Now multiply the right multiples on the target company’s financials. For instance:
      For example, if the target had $10 million EBITDA and a comparable range of EV/EBITDA multiples were 7x-10x, the implied valuation range is $70 million-$100 million.
      This yields a list of available values for the target from what historically purchasers have paid for similar companies.

Adjustment to account for the Control

Premium Precedent transaction analysis usually captures control premiums, which represent the extra price paid to gain control over a company by acquiring a majority interest in it. This is because buyers usually pay higher than the market price in order to gain control.

Conclusion

Precedent transaction analysis is an important valuation method for helping to determine a company’s value through the lens of actual past transactions.

Much like a reference-based method, this calculates the changing market dynamics (on as-reported multiples), including control premiums and what buyers are actually paying for companies by examining comparable past deals. This is particularly valuable in the scope of M&A, with control premiums included and significant market conditions involved.

However, this method has some limits, including the availability of data and potential distortion from these unique deal terms or market fluctuation at that time. As a result, it is more reasonable to incorporate DCF and some other methodologies when estimating value of target companies.