With accelerating automation and the rise of AI-powered financial analysis tools, the temptation to “go it alone” on your SME business valuation may well be strong.
However, SME business valuations involve more than just number-crunching, comprising a subjective assessment of comparable transaction data, the quality of management, IP, risk, as well as the wider market and industry trends.
Unrealistic valuations can deter would-be investors, while undervaluing cheats hard-working entrepreneurs of the value that they have built up in their businesses.
Why, then, does valuing SMEs require expert guidance?
The scarcity of SME transaction data
Contrary to the blockbuster mega-deals (think Capital One’s recent $35bn all-stock acquisition of Discover Financial), the ins-and-outs of small and mid-market M&A deals are often not disclosed, meaning that finding market comparables for SMEs is challenging.
An experienced business adviser, however, will be exposed to large volumes of historic and recent SME transaction data – which is crucial on a market approach to valuation where the average Income/ Enterprise Value (“EV”) ratio amongst comparable businesses is calculated.
As well as having access to proprietary data, an experienced adviser will also be well-placed to assess the wider market, put the average Income/EV ratio in context, and determine whether the return-on-investment for buyers would warrant any given valuation.
In 2022 and 2023, for example, inflation and the higher cost of capital depressed average and median revenue multiples, creating large “expectation gaps” between founders and prospective buyers.
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Get in touch to see how we can help youUsing the correct business valuation metrics
Valuing an SME goes beyond selecting from one of three main methodologies (income, market and asset approaches); it involves thinking about the narrative that each of the methodologies tells about the business, and blending them accordingly.
AI startups, for example, are attracting unicorn valuations even with capital-intensive operations and negative cash flow. For example, in June 2023, France’s Mistral AI attracted a valuation of $259 million during its seed funding round in June 2023 just one month after launch, despite having no discernible product.
A business valuation professional will look at the entire picture, factoring in the business model, stage of growth, the quality of management, low/high CAPEX, industry-specific dynamics and more, to arrive at a nuanced valuation that reflects the company’s potential, not just a financial snapshot.
They may combine methods, leading (for example) with Discounted Cash Flow (DCF) analysis as the primary valuation technique, supported by a market-based comparable companies analysis, while industry-specific valuation metrics may be applied where appropriate. SaaS providers, for example, may well be valued as a multiple of annually recurring revenue (ARR) to reflect revenue “stickiness”.
A business valuation professional will also avoid common valuation pitfalls such as failing to correctly account for balance sheet items such as cash, stock, debtors and corporation tax, or failing to correctly identify normalised underlying earnings.
The need for impartiality
Entrepreneurs typically have a deeply personal relationship with their businesses – which are the culmination of hard graft, sacrifice, and passion.
An experienced valuation professional will be able to abstract from the emotion and deliver independent, credible valuations that stand up to scrutiny.
And, in cases of shareholder disputes, divorce proceedings, or partnership dissolutions, an independent valuation provides an objective basis for negotiation and resolution.
