The Art of Business Valuation

CHAPTER 3Why Is Valuing Small Businesses Different from Valuing Larger Businesses?

The problem with valuing small and very small businesses is that there is an information gap on both sides of the model or equation.¹ Small and very small businesses are just not very good at data collection, much less providing it to third parties. Most small business owners manage by walking around. In addition, the best owners have a few indicators that tell them where they stand; perhaps incoming orders and cash balance; perhaps today's cost of goods. They have their one or two simple indicators and a feel for the business. This way owner/operators can run great businesses and keep overhead down. While this limits long-term growth, it creates significant overhead efficiencies. Consequently, this lack of data makes economic and business sense.

Therefore, even “reliable” sources cannot have data that is better than what the businesses have. Having reviewed hundreds of small business financial statements and tax returns, one of the few things I am sure of is that little of the data available from small businesses meets standards that larger companies must comply with, both to keep control of the business and for compliance with requirements like employment law, safety standards, loan covenants, taxes, and so on.

Many owners drive costs down in all areas, including bookkeeping and tax compliance. The result of this is many tax returns are prepared by certified public accountants (CPAs), enrolled ...