What Are Precedent Transactions?
Precedent transactions are one part of comparable analysis. It is the analysis of previous transactions which have taken place involving companies of similar market cap / revenue / location / industry to the company being valued. The idea being that similar companies should be traded at similar multiples, so if you can find out what multiples similar companies have been sold / purchased at, you can apply an average of those multiples to the company and approximate a valuation.
Using precedent transactions is useful because it is based on readily available public information, can assess market demand for certain types of companies, and can give an idea as to which other entities in the market may be willing to participate in the transaction being proposed.
Unfortunately there are some limitations to using precedent transactions. Some of these are that premiums paid have to be eliminated, the data available on the transactions may not be fully inclusive, the business and economic cycle will greatly affect valuations and transactions, and that it is extremely difficult to compare one transaction exactly to another, and therefore there is a degree of approximation involved.
The process for conducting precedent transaction analysis is as follows:
- Compile a full list of all transactions involving companies in similar industries and / or of similar size.
- Narrow down the list to have 5-10 transactions, preferably involving companies with similar revenues, market capitalizations, industries and geographical locations.
- Decide which multiples to use, the most common ones being Forward & Trailing EV / Revenue and Forward & Trailing EV / EBITDA.
- Calculate the average multiple values for the transaction companies and the values for your company.
- Apply the average multiples to your company to gain an idea of how it would be valued in a transaction.
- Comparable Analysis
- Discounted Cash Flow (DCF)
- Earnings Before Interest, Taxation, Depreciation & Amortization (EBITDA)
- Enterprise Value (EV)
- EV / EBITDA
- Football Field Graph
- Investment Banking Division (IBD)
- Market Capitalization
- Pitch Book
- Public Comparable Companies
- Trading Multiple