Most PE/VC firms estimate an organization’s value with the help of valuation approach. To review an organization, there must be enough knowledge of Venture Valuation, which is considered as the most holistic evaluation path. All valuations are based on the careful consideration of both hard facts and soft factors. And they are implemented with thorough risk assessment of the aspects like:
- Management
- Market
- Science and technology
- Financials/funding phase
To determine private company valuations accurately and objectively one must take help with different assessment methods that are mainly suitable for the evaluation of technology firms, with more growth potential and start-ups of all types.
In this article, let’s understand about the comparable company analysis and precedent transaction analysis.
Comparable Company Analysis
The objective of applying Comparable Company Analysis (CCA) method is to search for other public businesses that share characteristics with the private organization. These characteristics are industry, margins, revenue/size, geographies in operation, and age. For an established business, this process is much simpler. For instance, SaaS businesses will have dozens of the same kind of organizations because the market has become highly saturated in the last decade.
Most SaaS businesses founded during the last few years are still-loss making, usually has high revenue growth, and holds a high dollar-related net retention rate that compensates investors for the poor bottom line. In this case, for a PE/VC organization considering a buyout, the value lies in reviewing a discount in the organization relative to other publicly traded businesses.
To measure the discount, investors usually calculate industry averages of various valuation multiples. Continuing with the SaaS example, these metrics are traditional like EV/EBITDA, EV/Revenue, and Free Cash Flow/Share or industry-related metrics like churn rate, customer acquisition cost, lifetime value, and annual recurring revenue.
Precedent Transaction Analysis
Precedent Transaction Analysis (PTA) is a valuation approach, which is helpful to determine the value of an organization by comparing it to other same kind of firms that have been sold in the past. This method is commonly useful in investment banking and other financial industries to determine the value of an organization before making any investment decisions.
In this analysis, historical M&A transactions serve as precedents or benchmarks for estimating the fair value of the target company. It offers resourceful insights into market trends, pricing dynamics, and investor sentiment within a certain industry or sector. Apart from this, the accuracy and reliability of PTA is based on the quality of data and the relevance of the selected transactions to the present deal context.
Difference between Comparable Company Analysis (CCA) and Precedent Transaction Analysis (PTA)
Comparable Company Analysis and Precedent Transaction Analysis are two commonly used valuation methods in the financial industry. The CCA consists of comparing an organization to other publicly traded organizations in the same industry. Whereas PTA is related to comparing an enterprise to other enterprises that have been sold in the past. While both methods have their pros and cons, PTA is usually preferred in situations where there are not many publicly traded organizations in the same industry or when there is a lack of reliable financial data for comparable organizations.
CCA insights into the relative valuation of the target enterprise compared to its peers in the market. However, PTA offers details of the prices paid by acquirers in similar transactions and serves as a benchmark for estimating the target organization’s value in the current deal context.
The key data inputs for CCA are financial statements, market data, and valuation multiples of comparable publicly traded organizations, which are sourced from financial databases, industry reports, and public filings. The data inputs for PTA are transaction data (e.g., purchase price, deal structure, financial metrics) from past M&A transactions involving similar organizations, which are sourced from M&A databases, industry publications, and public announcements.
End Notes
Both CCA and PTA valuable valuation methodologies that are useful for financial analysis, but they vary in their methodologies, focus areas, data inputs, and usage. CCA compares the target enterprise to publicly traded peers, while PTA analyzes past M&A transactions involving similar enterprises. Both approaches offer valuable insights into an enterprise’s valuation, and their combined usage usually boosts the robustness and reliability of the valuation analysis.