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Financial Valuation: Applications and Models, + Website, 3rd Edition by James R. Hitchner

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Chapter 19

Valuation Issues in Small Businesses

WHAT IS A SMALL BUSINESS?

A small business is frequently defined as a business with less than $5 million in revenue. Such businesses usually are owned by individuals, family members, or employees, and are likely to be highly dependent on the owner/manager. They also tend to have lower-quality financial statements and less access to capital than larger businesses. Buyers of small businesses often expect to be involved in day-to-day management of the business and are very concerned with lifestyle issues. Higher risks are associated with these small businesses.

Lack of Management Depth

Small businesses often have a high degree of reliance on one or more key owner/managers. In extreme cases, the business may rely on a single person for sales, technical expertise, and/or personal contacts and may not be able to survive without that person. Professional middle managers are a luxury that small businesses seldom can afford. To be profitable, small businesses must operate with a very thin management group. In addition, leaders of small businesses frequently are entrepreneurs who are not comfortable with delegation of management duties to others and may not work well with middle managers.

Small companies are apt to have a board of directors composed of insiders— members of the owner’s family and/or employees. Thus they lack the diverse expertise and perspective outsiders can bring to a board of directors.

Lower-Quality Financial Statements ...

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