The Art and Science of Valuing Small Businesses: Insights from Value-Added Investors
Small businesses are the heart of Australia's economy, offering innovation, employment, and diverse opportunities. For value-added investors like Marlton Capital Partners, the process of valuing these businesses goes beyond mere number crunching. It's a blend of art and science, incorporating various factors to make informed investment decisions. In this article, we'll take a closer look at how value-added investors like Marlton Capital Partners go about valuing small businesses, with examples and references to publicly available statistics.
Understanding the Art of Valuation
Valuing a small business requires a keen understanding of its unique characteristics and potential. It's not a one-size-fits-all approach. Instead, value-added investors like Marlton Capital Partners take a holistic view that considers both financial and non-financial factors.
Financial Fundamentals
Financial data is the backbone of small business valuation. Investors delve into balance sheets, income statements, and cash flow statements to understand the financial health of the business. This data serves as a foundation for the valuation process.
Benchmarking Against Industry Standards
To establish a baseline, value-added investors benchmark small businesses against industry standards. For example, if a retail business demonstrates a profit margin higher than the industry average, it could indicate a strong competitive advantage1. Conversely, a profit margin lower than the industry average may require further scrutiny.
Earnings Multiples
One common valuation method is using earnings multiples. This involves calculating the price-to-earnings (P/E) ratio, which measures the price investors are willing to pay for each dollar of earnings. A higher P/E ratio may indicate that investors have confidence in the business's growth potential2.
Addressable Market Size
Understanding the potential market size is critical. Investors consider not only the current customer base but also the untapped market. For instance, if a small software company operates in a niche market with potential for global expansion, its value increases significantly3.
Supplier Tenure and Continuity
Long-standing relationships with reliable suppliers can be a valuable asset. This supplier continuity lowers the risk of disruptions in the supply chain. Investors assess these relationships to gauge the business's stability4.
Growth Trajectory
A business's growth trajectory is a critical factor. An investor looks at past growth rates and the potential for future expansion.
Working Capital Employed
Working capital management is another vital aspect. Efficient working capital utilisation can free up resources for growth and investment. Investors assess whether the business has an optimal balance between current assets and current liabilities6.
The Math and Accounting
While the art of valuation involves assessing qualitative factors, the math and accounting aspect provides quantitative support. Investors utilise various valuation models, such as the discounted cash flow (DCF) method, to estimate a business's intrinsic value7. They discount future cash flows to their present value, considering factors like expected growth and risk.
Conclusion: The Art and Science of Valuation
Valuing small businesses is a meticulous process, balancing the art of understanding unique factors with the science of quantitative analysis. Value-added investors like Marlton Capital Partners employ this approach to make informed investment decisions. The process considers financial fundamentals, industry benchmarks, growth potential, and the business's intrinsic value. In the end, like real estate and used motor vehicles, your business is worth what the market dictates. Which means what someone is willing to pay for.
*Note- At Marlton Capital Partners we not only bring capital to the table as a value-adding investor, but we also bring experience in running successful businesses large and small to create value and guide growth.
Register Your Interest
If you'd like to express an interest in partnering with Marlton Capital Partners please email
contact@marltoncapitalpartners.com.au.
Please share with us a summary of your business, your industry, and why you are interested in partnering with Marlton Capital Partners.
Disclaimer: This article is for informational purposes only and should not be considered financial or investment advice. Consult with financial experts before making any investment decisions.
References
Deloitte, "Global Powers of Retailing 2021," https://www2.deloitte.com/global/en/pages/consumer-business/articles/global-powers-of-retailing.html
Investopedia, "Price-to-Earnings (P/E) Ratio," https://www.investopedia.com/terms/p/price-earningsratio.asp
Australian Trade and Investment Commission (Austrade), "Market profile – Information and communication technology (ICT)," https://www.austrade.gov.au/australian/export/export-markets/countries-and-economies/canada/industries/information-and-communication-technology
Harvard Business Review, "Suppliers Are More Than Just Sources of Cost Savings,"
Investopedia, "Working Capital," https://www.investopedia.com/terms/w/workingcapital.asp
Corporate Finance Institute, "Discounted Cash Flow (DCF) Model," https://corporatefinanceinstitute.com/resources/knowledge/valuation/dcf-formula-guide