Article written by Marketing Team
SMEs and micro-businesses: how much is your company worth?
Every entrepreneur, at one time or another, has asked themselves the crucial question: “But really, how much is my business worth? It’s a question that resonates with particular intensity in the minds of managers of SMEs and micro-businesses. Often, these businesses are much more than a source of income; they represent a legacy, a dream come true, or the fruit of years of hard work. Knowing the value of your business is not just an accounting exercise; it’s also about embracing the history, sacrifices and successes that have shaped its course. With this in mind, we explore the different methods and approaches to business valuation, which go beyond mere numbers to touch the very soul of your business.
In general, the valuation of a company is particularly important in the context of mergers and acquisitions or stock market flotation. In the case of SMEs and micro-businesses, however, the primary reasons are often succession and, more rarely, the sale of the business to strategic or financial investors. But knowing how much your company is worth, even if you don’t want to sell it, is an enlightening piece of information that will enable you to take the full measure of what you have achieved and how to position yourself in the market.
There are many different valuation methods. Depending on the activity and size of the company, they can be categorised as follows (in ascending order of technicality and complexity):
1.Balance sheet approach, which determines net asset value, also known as substantial value.
2.The income approach, which results in a yield value.
3.Hybrid approach, which is a combination of the two above-mentioned approaches.
4.The cash flow approach, the best known of which is the discounted cash flow method.
5.The market approach, using multiples or comparable transactions.
It should be noted that the valuer often uses several valuation approaches to determine a relevant price range.
Approach 1 is based on the equity value resulting from a restated balance sheet, i.e. each item is presented at its economic value and not its accounting value. In this sense, it is a valuation based on the past (the creation of value for a company since its creation). However, a buyer is interested in a company’s future capacity to create value. For the seller, on the other hand, the substantial value represents a psychological threshold below which he will never want to negotiate. It is also important to bear in mind that this approach does not capture the value of goodwill. Goodwill elements such as brand image, customer portfolio, management know-how or the charisma of the director in managing the business are not presented under the various headings of a balance sheet, even when restated and presented according to the true and fair view concept.
Approach 2 focuses on a company’s earnings capacity over time, generally 3 to 5 years. It is therefore a future-oriented approach. The disadvantage is that a company’s result is influenced by the accounting methods applied. Using this method, the valuer must normalise the result in his projections, by decorrelating the result as much as possible from the impact of the accounting methods.
For an SME, the hybrid approach may often be sufficient. The best-known method, commonly known as the practitioners’ method, is a weighted average of net asset value for 1/3 and return on investment for 2/3.
Many argue that what makes a company valuable is its ability to generate cash. Approach 4 captures this capacity. Financial analysts use the adage “Profit is an opinion but cash flow is a fact” to remind us, quite rightly, that cash cannot be manipulated, unlike other indicators such as earnings. It also has the advantage of including any goodwill in the projections. The Discounted Cash Flow (DCF) method projects future cash flows and discounts them to their present value.
The DCF can perfectly well be applied to the valuation of an SME. That said, the valuator must always ask himself the question of the cost-benefit of such valuation approaches for an SME. This approach is technically complex and highly sensitive in terms of the choice of discount rate and long-term sustainable growth rate. The valuer will have to use complex methods to extrapolate these two rates. The cost of his services will be significantly higher. It all depends on the context and the reason for the valuation. If, for example, the SME is being approached by a private equity fund, the DCF approach will be almost unavoidable, as will the multiples approach. On the other hand, if the owner of an SME wants to transfer his business to his children, the valuer should be pragmatic and use approaches that are less costly but entirely relevant to the context.
Approach 5 is a relative valuation method. One of the activities of financial information providers is to value listed companies by industry sector. Then, for each listed company in a sector, they break down its value in terms of its sales, EBIT, EBITDA, earnings or any other key indicator to obtain what are known as multiples. For example, if the value (EV) of a listed company is CHF 800,000 with an EBITDA of CHF 100,000, then its EBIDTA multiple (EV/EBITDA) is 8.
Then, using the multiples obtained for all listed companies, financial analysts publish median multiple values for each business sector.
An appraiser commissioned to value an SME or micro-business cannot use these multiples as they stand. In fact, the valuer must take account of the notion of risk in his approach. The financial risks of unlisted companies are higher than those of listed companies. To factor risk into his calculations, the valuer will use techniques to deflate the multiples of listed companies. Following on from our example, by deflating the EV/EBITDA multiple of 8, he could arrive at a multiple of 6, which would be applicable to the unquoted company they want to value.
It should be noted that there are multiples for the value of a company’s assets (Enterprise Value) and others for the value of its shares (Equity Value). In corporate transactions, it is the latter that will be decisive, as it is a negotiation based on the value of the shares that are the subject of the transaction.
The most popular multiple is EBITDA. EBITDA is operating profit before depreciation, amortisation, interest and tax. In this sense, EBITDA is a good representative of cash-generating capacity, an essential concept in valuation.
However, a valuer will always use a number of multiples to enable him to carry out a more detailed analysis and establish a relevant range of values.
Finally, and provided that there have been recent (comparable) transactions in the same sector as the SME, the valuer can use these as a reference (benchmark) and further refine his analysis.
In addition to the various approaches, the current economic environment and market trends are external factors that also influence valuation. Similarly, growth prospects and future opportunities are key drivers of the value perceived by a potential investor (for example, for a start-up that is on the verge of registering a revolutionary patent). Above all, an investor buys a company’s future growth and its ability to create value.
Unfortunately, valuation errors, which are not uncommon, are often due to a lack of expertise and behavioural biases. A salesperson, for example, should be aware that they are subject to endowment bias. This is an emotional bias that tends to give more value to something you own than to something you don’t own.
Self-assessment can be risky, which is why it is so important to rely on specialists in financial analysis. These experts bring not only their experience and technical knowledge, but also an objectivity that enables an accurate and justifiable valuation.
Finally, if SMEs and micro-businesses were to retain three pieces of advice for valuing their business, they would be: recognise and manage emotional biases, ensure the quality and accuracy of financial information, and call on independent experts for an objective valuation. In short, knowing the value of your company is not a luxury, but a strategic necessity for any business wishing to embark on the road to growth and sustainability.