There is no such thing as “the” value of a business. There is a value estimated with a method, on stated assumptions and for a specific purpose: a sale, a new shareholder coming in, a family succession, a financing request. Change the purpose or the method and the result changes.
Value and price are not the same thing
A valuation is a reasoned estimate. The price is the outcome of a negotiation and depends on factors the valuation does not contain: synergies for the buyer, the seller’s urgency, the alternatives available. A sound valuation tells you how far it makes sense to go.
The financial method (DCF)
The DCF discounts future cash flows at the cost of capital and adds a terminal value for the years beyond the plan. It is the most consistent method when the business has predictable cash flows and a credible plan.
Its limitation is sensitivity to assumptions: small changes in the discount rate or in long-term growth move the result considerably. That is why it should always come with a sensitivity analysis.
Market multiples
Multiples apply to the business the ratios observed for comparable companies or similar transactions, for example enterprise value to EBITDA. They are quick and anchored to the market.
For an SME, however, finding truly comparable companies is difficult: size, liquidity and customer concentration are often very different. And the multiple must be applied to a normalised EBITDA, not the one in the financial statements.
The asset-based approach
The asset-based approach starts from equity and adjusts it to current values: property, inventory, receivables, provisions. It suits asset-rich companies, such as property companies, or those with low profitability. On its own it does not capture goodwill, which is why mixed methods are often used.
From enterprise value to equity value
DCF and multiples estimate the value of the business as a whole. To reach the value of the shares, net financial debt is deducted and debt-like items are taken into account, such as overdue tax and social security liabilities. This is where many disagreements in negotiations arise.
Which method to choose
Usually one main method and one cross-check method are used, chosen according to the sector, the company’s stage and the purpose of the valuation. The most honest result is not a single figure but a range, with the assumptions behind it.
Further reading
Can I help you with this?
If you are considering a sale or a new shareholder, the first step is to understand what the business could be worth and what to fix first.
