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Many SMEs Worth Half Their Owners’ Expectations

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Many owners of small businesses are drastically overestimating the value of their company by relying on metrics more appropriate to larger corporations, a group of accountancy and law firms has suggested.

There are a number of reasons a business owner would want to know the valuation of their SME, from a sale of the enterprise to disputes with shareholders to divorce or probate proceedings, or simply to ascertain where the company stands.

But to arrive at this value, many are taking shortcuts, relying on indexes such as the BDO Private Company Price Index. The BDO Index shows the average Enterprise Value to Earnings Before Interest, Tax, Depreciation and Amortisation EBITDA of large businesses, whose finances are publicly available.

The BDO index currently stands at 10.0. If using it, the owner of a small business with annual profits of £1 million would calculate their company is worth £10 million. 

However, new data from the UK200 Group suggests this could be an overestimation.

Companies in the UK200 Group provide services to 150,000 SME clients, the majority of them valued at less than £25 million. That gives them unique access to the finances SMEs and has enabled them to develop an alternative index for small businesses. Rather than 10.0, they discovered that the mean EV/EBITDA ratio of a smaller company valued by its members was actually 5.6 in 2016.

Using the SME index, a small business with £1 million in annual profits would be worth £5.6 million, a little over half what owners using the BDO would arrive at. The £4.4 million discrepancy could be significant for business strategy, investment and exit plans.

Smaller companies have a lower EV/EBITDA ratio than larger companies because they qualify for less investment and funding but also simply because they behave differently, Simon Blake, Chairman of the UK200Group’s Corporate Finance Panel, explained.

“In smaller companies, there is a greater level of entrepreneurial impact on the data that is used to create a valuation. Small business owners may put costs through the business that a large corporate would not. For example, at a firm I have valued the owner was taking his senior management on trips around Europe to celebrate business achievements. Those costs would not be incurred in a larger corporate firm in a similar industry. Because they are non-recurring costs and are unusual, these trips have taken £50,000 off the firm’s annual profits, potentially reducing the valuation of the business based on the 10x multiple above by £500,000 erroneously,” he said.

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