Digital and Tech business valuation – why traditional methods don’t apply?

In our previous article, we discussed why and when you should value your business. In this article, we will discuss why the traditional methods of business valuation don’t apply when valuing a small business, understand what are business valuation multipliers, the key factors that influence them and eventually the valuation of your business. 

It is important to recognise that the traditional methods of business valuation were built by corporate finance professionals for large corporations and listed companies. Although the overall principles are right, these methods need to be adapted when valuing a small business especially a digital/ technology SME, to get a more accurate value.

Some of the most common methods of business valuation are:

1. Discounted Cash Flow (DCF)
2. Multiples based valuation – e.g. Price/Earnings (P/E) ratio or EBITDA multiples
3. Seller’s Discretionary Earnings (SDE)

The method you choose depends on your business, its circumstances and the reason for valuation. There is no single right method. However, as a digital / tech SME, you need to choose the right method based on your objectives for the valuation and adapt it to get to a more accurate value for your SME. You may need to use more than 1 methods to better understand the variance due to different methods.

Why traditional methods don’t apply to valuing a small business?

Following are some of the main reasons why SMEs need to adapt the traditional methods 
when valuing their business:

1. Factors determining multiples vary for SMEs and don’t apply directly as they would for larger businesses/ corporates
2. Growth factors and trends are different for SMEs especially in the disruptive/ +tech sectors
3. Traditional methods don’t account for upward (sunk) investment in a small/ start-up business
4. Traditional methods don’t take into account an acquirer’s strategy  
5. Traditional methods don’t take into account revenue models of SaaS/ tech firms 

We have discussed these reasons in more detail in our blog “why traditional methods of valuation don’t apply to valuing a small business?”

As we mentioned above, one of the most common methods of business valuation uses multiples of earning e.g. EBITDA multiples to calculate the value of your business. These multiples, known as “business valuation multipliers” can significantly increase or decrease the final value of your business. As a result, it is essential you understand the different factors that can influence the calculation of the multiplier. By knowing this, you can better prepare your business for valuation and ensure you get the maximum value for your business. 

Key factors that influence business valuation multipliers

Some of the key factors are: 

1. Financial performance
2. Market industry type and trends
3. Owner dependence
4. Strength of the customer base
5. Goodwill and brand reputation
6. Size of the business
7. Age of the business

These factors are discussed in more detail in our blog “what factors influence business valuation multiplier?” 

It is important to note that a single factor alone can’t significantly influence the calculation of the multiplier. However, combining and evaluating all of these factors will influence it. To understand all the key factors you ought to consider when valuing your digital/ technology business and the factors that will influence your business valuation multiplier, get in touch with one of our business growth consultants.