Precedent Transactions

What are precedent transactions?

Precedent transactions (German: Transaktionsvergleiche, also called transaction comparables) are completed acquisitions of comparable companies whose purchase prices serve as a benchmark for valuing another company. Their evaluation is called precedent transaction analysis. From the enterprise value paid (Enterprise Value) and the metrics of the acquired company, multiples are derived, that is, ratios such as "enterprise value divided by EBITDA". The enterprise value is the purchase price for the shares plus the debt assumed and less the cash acquired. The multiples are then applied to the company being valued.

The idea corresponds to estimating the price of a detached house from the prices actually paid recently for comparable houses in the same area. As there, what matters is that the comparison objects are genuinely comparable and that the prices do not stem from a different market situation.

The method is one of the multiple-based approaches to business valuation and is used above all in company sales. Sellers and their advisers use it to support their price expectations, buyers justify their offer to committees and financing banks, and valuers use it to check the plausibility of a capitalised earnings value (Ertragswert). The analysis appears in valuation documents and investment papers, rarely in the information memorandum, the detailed company description for prospective buyers. Because it is based on prices actually paid for entire companies, it is regarded as close to the market. Its limits lie in the available data and in comparability.

Precedent transaction analysis in six steps

Formula: transaction multiple = enterprise value of the transaction ÷ EBITDA or revenue of the acquired company; enterprise value of the valuation target = own metric × median of the multiples

The analysis follows a fixed sequence:

1. Selection of the peer group by business model, industry, size, region and period.
2. Determination of the enterprise value of each transaction: purchase price for the shares, extrapolated to 100%, plus the net financial debt assumed (financial debt less cash).
3. Assignment of the acquired company's metric at the time of the transaction, usually EBITDA or revenue of the last twelve months.
4. Adjustment for peculiarities of the purchase price structure, such as contingent parts of the purchase price.
5. Evaluation of the adjusted multiples by median and range rather than by average. The median is the middle value of a series ordered by size; individual outliers hardly shift it.
6. Transfer to the valuation target with premiums or discounts for differences in size, growth and profitability.

Depending on the business model, the EBITDA multiple is evaluated or, for fast-growing companies without profit, the revenue multiple. The metrics of the peer companies and of the valuation target must be defined in the same way. In valuation documents the evaluation usually appears as a table with date, buyer, target company, enterprise value, metric and multiple for each transaction, with the median and range below.

Precedent transactions and comparable companies

Listed peer companies (trading comparables or comparable companies) provide prices for individual shares traded on the stock exchange without influence over the management of the company. Transaction comparables provide prices for taking control of an entire company. They therefore contain a control premium (Control Premium), that is, a surcharge for being able to steer the company oneself in future. They often also contain part of the synergies that the buyer expected from combining the company with its own business and passed on to the seller in its offer.

This determines their use. For the sale of a majority or of the entire company, for example in a trade sale to a strategic buyer, transaction comparables are the obvious benchmark. For a minority stake or a valuation from the perspective of a financial investor without synergies, they can be transferred only with discounts. Stock market comparisons are up to date every day, while transaction comparables reflect the market at the time of signing of the respective contract.

Data situation in Germany

The purchase prices of mid-sized transactions are rarely published in Germany. Usable information is found mainly in announcements by listed acquirers and in their consolidated financial statements, which partly disclose acquired companies and purchase prices. Further sources are the annual financial statements of the acquired companies filed in the German company register (Unternehmensregister) and paid transaction databases.

The data are incomplete. Often the metrics of the acquired company at the time of the transaction are missing, or the published price contains components whose payment is uncertain. A peer group of a few well-documented transactions is therefore more meaningful than a long list of uncertain information.

Adjustment for structure, timing and buyer

A reported purchase price figure says little as long as its structure is unknown. An earn-out that is paid only if ambitious targets are reached is worth less than a payment at closing. A vendor loan shifts part of the price into the future, and consideration in shares of a listed acquirer makes it dependent on the development of that company's share price. For the comparison, the price is therefore reduced to its fixed component and a cautiously valued contingent component.

Timing and buyer type are added to this. Transactions from an environment with a different interest rate level or different market sentiment are comparable only to a limited extent. A strategic buyer that expected high synergies paid a price that a financial investor would not pay. Distressed sales from a crisis or insolvency are generally excluded, because their price does not reflect the value of a going concern.

Worked example: precedent transactions for a software service provider

For a software service provider with an adjusted EBITDA of EUR 1.8 million and net financial debt of EUR 1.5 million, four transactions of recent years are evaluated. All figures are hypothetical.

• Transaction A: enterprise value EUR 13.0 million ÷ EBITDA EUR 2.0 million = 6.5
• Transaction B: 10.5 ÷ 1.5 = 7.0
• Transaction C: 20.0 ÷ 2.5 = 8.0
• Transaction D: reported enterprise value EUR 22.0 million, of which up to EUR 8.0 million as an earn-out; EBITDA EUR 2.0 million; reported 22.0 ÷ 2.0 = 11.0
• Transaction D adjusted: fixed component 14.0 ÷ 2.0 = 7.0; with the earn-out counted at half (14.0 + 4.0) ÷ 2.0 = 9.0
• Unadjusted, ordered by size 6.5; 7.0; 8.0; 11.0: median as the middle of the two middle values (7.0 + 8.0) ÷ 2 = 7.5; average (6.5 + 7.0 + 8.0 + 11.0) ÷ 4 = 8.1
• Adjusted with 9.0 for transaction D: median 7.5; average (6.5 + 7.0 + 8.0 + 9.0) ÷ 4 = 7.6; range 6.5 to 9.0
• Enterprise value of the valuation target: 1.8 × 6.5 = EUR 11.7 million; 1.8 × 7.5 = EUR 13.5 million; 1.8 × 9.0 = EUR 16.2 million
• Equity value at the median: 13.5 minus 1.5 = EUR 12.0 million

The median hardly reacts to the adjustment, the average clearly does. Anyone who relies on the reported price of transaction D would arrive at an enterprise value of EUR 19.8 million with the multiple of 11.0, around EUR 6 million above the adjusted median. An informed buyer will put this difference on the table in the negotiation.

Distinctions: precedent transactions, comparables and benchmark valuation

• Trading comparables (comparable companies): multiples of listed peer companies. They reflect the price of tradable minority shares, whereas transaction comparables reflect the price of control.
• Benchmark Valuation: valuation by reference values, above all the valuations of comparable funding rounds. These concern minority stakes with preferential rights, whereas transaction comparables concern the acquisition of entire companies or majorities.
• Control premium: the surcharge for control, which is contained in transaction comparables. It explains part of the gap to stock market multiples.

Common mistakes

• Selection by desired result. A peer group made up of the three highest transactions does not convince a buyer who knows the others. What is credible is the complete group with median and range.
• Reported price instead of actual value. Contingent parts of the purchase price, vendor loans and payment in shares of the acquirer distort the multiple if they are included at their maximum amount.
• Different market environment. Transactions from a phase with considerably lower interest rates or higher valuations lead to inflated expectations if they are not adjusted.
• Distressed sales included. Prices from crisis or insolvency sales depress the comparison and do not represent a going concern.
• Size differences overlooked. The acquisition of a market leader with several hundred million euros of revenue is no benchmark for a company with a fraction of that.

Frequently asked questions

What is the difference between precedent transactions and comparable companies?

The nature of the price. Precedent transactions are based on purchase prices for entire companies, comparable companies on stock market prices of individual shares. Transaction multiples are therefore often higher, but not necessarily. The control premium and synergies raise them. Smaller size, lack of tradability and the dependence of mid-sized target companies on individual people can narrow or reverse the gap.

How is enterprise value calculated with precedent transactions?

In three calculation steps. For each comparable transaction, the multiple is formed, that is, enterprise value divided by EBITDA or revenue. From the adjusted multiples, the median and range are determined. The own metric times the median gives the enterprise value, and after deducting net financial debt the equity value.

Where does the data on comparable transactions come from?

From several sources: announcements and financial statements of listed acquirers, filed annual financial statements of the acquired companies, transaction databases and conversations with buyers, advisers and financiers. No source is complete in itself, so the information is cross-checked.

How old may comparable transactions be?

There is no fixed limit. As a rule of thumb, transactions of the last three to five years are used and weighted by recency. The more interest rate levels and market valuations have changed since, the less informative older transactions are.

Why do buyers often know more comparable transactions than sellers?

Because they acquire companies regularly. Strategic acquirers with their own acquisition history and financial investors have experience from earlier processes, including those in which they did not win. A seller, by contrast, usually sells only once.

The Roemer Capital view

Before a sale process, Roemer Capital compiles the peer group from publicly available information, filed financial statements and conversations in the market and adjusts each transaction for its purchase price structure. Roemer Capital shows the complete group with median and range, including the low values, because a selection of only the highest prices does not hold up in negotiation.

If a buyer names a supposedly usual multiple, Roemer Capital responds with this adjusted group. It also shows what sets the client's company apart from the comparison: growth, share of recurring revenue, customer retention and profitability. In this way the conversation shifts from an assertion to a verifiable calculation.