Picture this: Imagine you've got some awesome neighbors and guess what? There's this super popular store right near your place. It's basically like an offline version of Amazon, where you can find absolutely anything you need.
Now, you and your neighbors are regulars at this place because you all have similar tastes. It's like your go-to spot for shopping.
There's this awesome new collection of Televisions with super smart features at the store that caught your attention. Your neighbors have decided to purchase the latest models. Even though the price is fixed, you have a chance to get it at a lower price if you're good at negotiating.
So, there's this super cool TV at the store and you're thinking of getting it. You really want to buy it, but here's the thing - you're not sure if the price is worth it or not. You wanted to get an idea of the price and asked your friends how much they paid for their TVs. Don't forget, all your friends have recently bought TVs.
Most of the items are pretty similar in terms of size, picture quality, warranty and other features. What you can do is gather data from all your friends about the price and features of the products purchased by them. Once you have all that info, you can choose something as a reference point, like the size of the TV or the resolution or its warranty. Using this reference point, you can then estimate whether the price of product you wanna buy is worth it or not. If you believe the product is reasonably priced, you will proceed with the purchase. Otherwise, you will not.
What you just did was try to figure out how much you should pay for that thing you wanna buy. And you did this by looking at the prices of similar products that were recently acquired.
Companies also engage in similar activties, and it's called precedent transaction analysis.
When a company is interested in buying another company, they go through a process of evaluating the target company's (selling company's) worth. They do this by assessing its business and using different methods to determine its value. One of these methods is called precedent transaction analysis.
Companies start by searching for other transactions that have taken place in the same industry, preferably in the recent past. They gather information on the prices paid for the companies that were recently acquired. They use a multiple, such as EV/EBITDA or EV/Revenue, as a reference point to estimate the value of the company they are targeting. Subsequently, a variety of valuation multiples are employed to determine the potential valuation ranges.
Suppose there are five companies - A, B, C, D, and E - that were recently acquired. Let's say the EV/Revenue multiple has a low range of 5x and a high range of 7x. And the target company's revenue is $500 million. That means the target company's valuation could be anywhere from $2,500 million on the low end to $3,500 million on the high end.
Companies are also keen on obtaining information regarding the premium paid to the shareholders in order to acquire the Company. Control premium is the additional amount of money that a company pays when they acquire another company. This premium is usually expressed as a percentage and is paid over the current market price of the company being acquired.
This is done to encourage the current shareholders to sell their shares and give up their ownership. Without a reasonable control premium, it is unlikely that a buyer will be able to get a controlling stake in the company they want to acquire, as the current shareholders need a good reason to give up their ownership.
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