Chapter 16 • Small businesses
16.8 Valuation of small businesses
The existence of an apparently efficient market for the securities of large businesses
implies that, unless we have access to inside information, there is good reason to
believe that the best estimate of the security’s value available to us is the current mar-
ket price. With small businesses, as we have defined them, this will not be true since
there is no current market price. Nonetheless it is sometimes necessary to value the
ordinary shares of small businesses, either to fix a price for a transfer for value (a sale)
or where the transfer has been partly or fully a gift and a value is needed for capital
gains or inheritance tax purposes.
There are basically four approaches that can be taken to such a valuation. We
should bear in mind that we are seeking by each approach to value the equity of a
business. Since each one has the same objective, in theory they should, if used cor-
rectly, give the same result. This they will not usually do, possibly reflecting inefficien-
cies or imperfections in the market for real assets. We shall now look at each approach
in turn.Dividend yield
The dividend yield approach is based on the notion that the ordinary shares of two
different businesses should have a similar dividend yield provided that the businesses
are roughly similar in size, activity, capital gearing and proportion of profit paid as
dividend (dividend cover). If the shares of one of these businesses are listed and
valued by an efficient market (such as the London Stock Exchange), this enables us to
value the other one.Figure 16.2
Sources of
finance for small
businesses, 2002
to 2004
Source: Cosh and
Hughes (2007)