How SME owners can escape the small-company valuation curse
Increase the valuation of your SME with a these few tips.
From our experience when advising on the sale of SME, most buyers/investors have a pre-determined P/E valuation multiple range of between 4 to 7x of earnings. This situation is awkward for most SME owners because they cannot understand why their companies could be valued so low while other high-flying, cash-burning startups could be 100x more valuable. In addition, the SME owners could use listed companies multiples as a benchmark and then apply a "private-company" discount of e.g. 50%. However, the SME owners valuation expectations of 10x P/E or more almost never materialise.
In our view, the number one reason why valuation multiples are so much lower for SMEs is:
Low Growth Potential (Real or Perceived)
Conversely, the number one reason why multiples are much higher for publicly-listed but unprofitable companies is:
High Growth Potential (Real or Perceived)
If shareholder wealth is a function of both a company’s earnings and its P/E multiple, can anything be done to raise the P/E?
The table below shows the linkage between the P/E multiple and the expected annual earnings growth rate.
We offer a few tips:
1) Develop a clear story of historical and future growth. The SME owner needs to articulate a growth story which is compelling and acheivable.
2) Reinvestment of profits. Rather than pay dividends, reinvest the dividends to grow revenues. A clear revenue growth trend often allows for a valuation premium.
3) Know the intention of the buyer/investor. If the investor is a financial buyer who intends to roll-up your company into a bigger entity and then sell it later, it is useful to know the synergies and then justify for a higher valuation multiple.
4) Transform the Company's operations first. Often, it is better to improve the Company's operations and market perception first. We can then demand for a higher valuation multiple later.
When we source for buyers for SME, we always have in mind the points above because valuation multiple expansion is often a smarter way to extract higher shareholder value.