Business valuations and the role played by risk
Dan Bowtell of Smith Cooper argues that the valuation of a business of any size depends on many internal and external factors, not least risk
"For all companies, whether small or large, risk (and the company’s ability to mitigate it) is fundamental to its valuation."
In this short article, Dan Bowtell, EMEA Chair of Alliott Group's M&A Services Group and partner at Smith Cooper, weighs up the pros and cons of large and small businesses and how this impacts their valuation in their specific markets.
There is no denying it- larger businesses are typically more sought after in the M&A world. They often attract a wave of investors for myriad reasons including their return on investment, their scalability and their access to economies of scale.
However, risk (and a company's ability to mitigate it) is fundamental to the valuation of all companies small or large.
A large business typically has the basics well established – a diverse product range, an established brand and customer base, a well-trained workforce and a presence in numerous market places - all of which are factors that reduce risk for investors.
A small business, however, may not necessarily have each of these factors in place, and are therefore considered riskier. As a result, this reduces the valuation of a small business. It doesn’t, however, reduce their opportunity to deliver substantial financial rewards for their owners when eventually sold.
With large businesses, investors typically exist in a ‘sellers’ market’, and therefore have less bargaining power, which makes intuitive sense as they usually attract lots of high quality investors.
On the opposite end of the scale, smaller business don’t typically attract as many investors, creating a ‘buyers’ market’, meaning interested investors have greater negotiation power.
Large companies are better equipped to withstand changes in the economy, and as a result are able to deliver more stable and dependable financial returns – reducing risk.
However, a small business is arguably more adaptable to changing climates. Typically accumulating less revenue than a large business, they are better equipped to respond to changes in the economy, making them equally worthwhile investments.
The valuation of a business is not objective and will depend on many other internal and external factors.
Need advice on a business valuation or related corporate finance matter?
Speak to a member of Smith Cooper's award-winning corporate finance team. In the first instance, please contact Dan Bowtell.