Ever wonder how valuations of small and large businesses differ from each other? To be sure, some things should be obvious. For example, a big bell weather corporation looks a lot different than a mom and pop shop around the corner.
Now compare a single owner-operator professional practice to a multinational firm. A tiny private medical or accounting practice looks more like a job for its owner. On the other hand, a large law firm has rules about practice ownership and a layer of institutional management.
Now let’s say you need to value a small manufacturing company. Should you just pull together valuation multiples from sales of large manufacturing firms and apply them directly to your subject? Probably not. Apples and orange comparison, no doubt.
Glaring differences between big companies and small private firms should alert you to be careful when approaching your valuation. But what should you focus on?
Here are the top 3 areas that affect how you handle valuation:
Pay special attention to the way your subject business is set up as an organization. Legally, most small businesses tend to be pass-through entities, such as S-corporations or LLCs. In addition, accounting practices may differ. While many small companies may use cash accounting, most big businesses use formal accrual. Moreover, access to debt and equity capital usually differs a lot depending on company size.
Business sale transactional differences
The way small business ownership interests sell does not look anything like a public company stock offering. Unloading stock in a public company would take you seconds. On the other hand, selling a small business is a major project.
Market data differences
You have plenty of choices when gathering market data on publicly traded companies. And the quality of this data tends to be good. That is because public companies must comply with regulatory rules in order to sell their stock to the general public. As a result, the data quality is high and you can easily get it, often at no cost.
On the other hand, collecting and analyzing market data on private companies is complicated. Data quality tends to be spotty, and you may find it difficult to get enough market data to use in your valuation.
Hence, you should carefully consider the choice of valuation methods and, especially, market data when valuing small businesses. For example, you can apply the discounted cash flow method to value companies of any size. But valuation methods such as the multiple of discretionary earnings or capitalized excess earnings may serve you equally well in small business valuations.