Valuation plays a central role in our mediation practice. Whether it is a business conflict or a conflict of interest (buyout, buyout, buyout), the participants must jointly arrive at a price. But how do you establish the value of an SME valuation?
There are two frequently used methods: the multiple method and the discounted cash flow method (DCF). One method is correct but complex, the other is simple but deals with price and not value.
Valuing is looking ahead, forecasting and estimating what the company will earn in the future. It requires an educated forecast of revenues, margins, costs and investments. And it requires estimating the risks of the business. This is complex but the only right way.
Discounted Cash Flow is about the business, its revenue model and the risks of the business. DCF says something about the value of your business. Multiples are about averages of transactions as published by a number of databases. Multiples are about prices in the market.
EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization. Or: Earnings before taxes, interest and adjusted for depreciation and amortization.
Now what are the dangers in using multiples:
- Averages: multiples are averages. But the underlying transactions vary from high to low. Chances are your business is not average but higher or lower than average.
- Which EBITDA: do you use the last EBITDA or the average EBITDA of the last 3 years or maybe the budgeted EBITDA for current year?
- Effect: suppose the multiple in your sector is 5.5 on average. Every euro extra EBITDA increases the value of your company by 5.5 euros. But is that really true?
- Earnings model: multiples say nothing about the sustainability of your earnings model. Or about your plans to invest in innovation, process improvement or product development
- Investments: multiples do not take into account the annual investments needed to maintain the business
- Risk profile: multiples do not take into account the underlying risks of the company
- Differences in databases: Brookz ' multiples are higher than those of Marktlink and Bedrijventekoop. The differences are significant.
- Sectors: all subsectors are grouped together, even if they do not have much to do with each other
As an example, take two plumbing companies. One plumbing company works for regular customers, such as construction companies and property managers. It is a family business and the intended successor is already working in the business. The business is growing, investing in new technology and has no debt. Margins are stable and the business easily acquires new employees because of its excellent reputation. The other plumbing company is a sole proprietorship with a DGA and a few mechanics. There are no regular customers; everything goes through via. There is no successor and no money for innovation. The DGA takes all the money out of the business and there are two lawsuits pending from dissatisfied customers.
Two completely different businesses with the same multiple.
So why do we see multiples coming back so often? They are easy to find and it is easy to apply. You skip a very complex process of forecasting and assessing risk. And you don't have to invest in an expensive valuation report from an expert. But a multiple says nothing about your business, its market value, risks and the market in which you operate.
