Challenges regarding SME valuation
The following challenges are based on Damodaran, 2002 and Halter and Schröder, 2010.
- The owner's salary does not reflect market conditions. There often are unpaid labour inputs from family members. Too low rents are set on commercially used properties.
- Emphasise on high private loans instead of equity.
- Existence of covert securities such as guarantees for bank loans.
- SMEs operate under far looser standards, and there can be wide differences between firms on how items are accounted for.
- There is far less information about private firms in terms of both the number of years of data and the amount of information available each year.
- The absence of a ready market for private firm equity.
- The absence of separation between the owner and management can result in an intermingling of personal expenses with business expenses, and a failure to differentiate between management salary and dividends (or their equivalent).
"Identity" or "arm's lenght" issues
The following challenges regarding SME valuation revolves around identity/arm's lenght issues and is based on Vella, 2007.- A perception that “the business is the owner”.
- Dividend, investment and other policies may be driven by tax planning and personal considerations rather than commercial considerations.
- Remuneration of family members may not reflect a fair reward for effort on a commercial arm’s length basis (it may be more or less than that amount). There may be no clear delineation between return to labour and return to capital/risk.
- The owner’s perceptions of “value” may be distorted.
- Dependence upon the owner(s) for financial support, e.g. by way of guarantees or loans.
- Organisational definition (allocation of management responsibilities) may be “fuzzy”
Size issues
The following issues regarding size and SME valuation is based on Vella, 2007.-
Lack of management depth/dependence upon one or two key personnel.
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Dependence upon key customers or suppliers.
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Lack of diversification (if this is important in the relevant industry).
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Inability to capture economies of scale.
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Lack of geographical spread where that may be appropriate.
Information issues
(based on Vella, 2007)- Inadequate internal dissemination of information.
- Availability of relevant external data may be restricted.
- Inadequate availability of information (poor systems, no audit, accounting standards not applied).
Market issues
(based on Vella, 2007)-
Lack and depth and organisation of market for shares – possibly lack of market at all for minority holdings.
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The shareholders may all be related or closely associated which may preclude acting at arms length.
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No mechanism for ownership transition.
- Challenges