How is a company valued? A practical SME example
Company value rarely comes from one formula. Explore common valuation methods and a worked example from adjusted EBITDA to equity value.
A company's value cannot usually be calculated reliably with a single formula. Valuation considers the cash the company could generate for its owners, its assets and liabilities, and the risks in the business. Several methods are often used alongside one another for an SME to see whether they give a consistent picture:
- earnings- or cash-flow-based valuation;
- multiples based on EBITDA or another earnings measure; and
- asset-based valuation.
Value is not the same as turnover
Turnover indicates size, but says little about profitability. Two companies can each generate €1 million in turnover while one has €200,000 of EBITDA and the other makes a loss. Valuing most SMEs on turnover alone is too crude.
EBITDA is a useful starting point – once adjusted
Transactions often use EBITDA. Before applying a multiple, consider whether reported EBITDA reflects normal earning capacity. Adjustments might relate to:
- one-off costs or income;
- an owner's salary that differs from market rates;
- personal costs unrelated to the business;
- an exceptionally good or bad year; or
- necessary expenses that were deferred.
Only adjusted performance provides a sensible starting point.
Worked example: a profitable SME
This example illustrates the calculation only. The multiple is not a recommendation for any sector.
| Adjusted company EBITDA | €300,000 |
| Illustrative multiple | 4.5× |
| Enterprise value | €300,000 × 4.5 = €1,350,000 |
The €1.35 million here is enterprise value. If the company has €350,000 of interest-bearing debt and €100,000 of surplus cash at completion, net debt is €250,000. Its illustrative equity value would therefore be:
€1,350,000 − €250,000 = €1,100,000.
This shows why “EBITDA times a multiple” does not yet tell you the price for the shares.
Where does a suitable multiple come from?
A multiple reflects growth, risk and quality of earnings. It may be higher for predictable, growing profits, a diverse customer base, strong market position, management not dependent on the owner, recurring revenue and modest investment needs.
It may be lower where one customer dominates sales, the business depends heavily on the entrepreneur, profits are weak or volatile, substantial investment lies ahead, contracts or reporting are unclear, or the industry's outlook is poor. Companies with the same EBITDA can therefore justifiably have very different multiples.
Sensitivity analysis shows the effect of assumptions
For the company in the example:
| Multiple | Enterprise value | Equity value |
|---|---|---|
| 4.0× | €1,200,000 | approximately €950,000 |
| 4.5× | €1,350,000 | approximately €1,100,000 |
| 5.0× | €1,500,000 | approximately €1,250,000 |
A change of one whole multiple point changes equity value by €300,000. A valuation must therefore explain why the chosen multiple or other assumption is appropriate for this particular company.
What is asset-based value?
Assets are valued at their fair market values and liabilities deducted. This matters particularly for businesses with significant property, investments or fixed assets. For a profitable service company, business value may be much higher because of relationships, people, brand and future earnings.
What about discounted cash flow?
A cash-flow valuation forecasts future free cash flows and discounts them to present value using a return requirement reflecting the business's risk. It has a strong theoretical basis, but depends heavily on forecast quality. In an SME, a few percentage points' change in growth or profitability can significantly alter the result.
What is the “right” value?
There is no single objective market price until a buyer and seller agree a transaction. Valuation develops a reasoned negotiating range and explains the sources of value. Strategic benefits, competing buyers, deal terms, financing and negotiating positions also shape the final price.
When valuation underpins a sale, succession, share exchange or shareholder arrangement, use the company's real figures and circumstances. JTT performs company valuations as standalone assignments and as part of M&A transactions and other corporate transactions. If you are considering a sale, read how an external adviser can help.
