Business expansion and operational viabilities are two crucial factors for Small and Medium-sized Enterprises (SMEs), and to fund these necessities raising capital is imperative. Unlike startups, the job is easier said than done for SMEs. Formal credit lines are limited, and raising debt in informal setups creates a cash and liquidity crunch at a later stage, suffocating SMEs’ growth prematurely.
As a result, equity funding is gaining traction in the small and medium-sized business ecosystem. However, a lack of understanding in accepting reasonable valuation numbers and an inefficient selection of valuation companies often cost SMEs golden opportunities. Thus, SMEs must make the right choice for the company evaluating their businesses and be flexible by visualizing a larger picture.
Valuation-only firms or investment banks for the optimal valuation?
There are two types of companies that help SMEs with valuation to raise equity capital:
- Valuations only firms
- Investment banks that provide valuation + fundraising
While valuation-only firms eat numbers for breakfast, they do not possess the same hold over company valuation and funding as an investment bank. Often SMEs get numbers derived from prediction biases by opting for valuation-only firms.
These numbers are far from reality but make business owners/promoters happy. However, a largely deviated valuation number can lead investors to forgo funding and SMEs to lose the growth expansion.
On the other hand, investment banks are seasoned players in this game, and as they provide valuation + fundraising, the probability of rejection or delay in funding is minimal. It makes investment banks ideal for SMEs to raise funds and avoid receiving inflated/deflated valuations.
Consideration of past performances and room for flexibility
Future predictions are indispensable, but SMEs should also consider their past performances. Startups don’t have a past, but SMEs do, making it a crucial element for investors considering funding a business. Thus, evaluating numbers for raising equity using future predictions alone could deprive SMEs of funding.
Reaching a valuation based only on the forecast will likely create a gap between the highly ambitious future and the existing business reality. If the valuation is too optimistic compared to the performance track record, the investors are likely to discount it. After all, their goal is also to get value for their investments. The future is always painted to be brighter; it is the past that gives a reality check.
As a result, SMEs need to be more flexible in their valuation numbers. Being adamant about the numbers can result in losing out on growth opportunities and cost more in the long run.
How to make the right choice?
Now comes the vital question of how SMEs can choose the right valuation company and can verify the given valuation number to avoid instances of funding rejection.
For choosing the right valuation agency/investment bank, SMEs need to take a peek at the performance records of the agency/ bank. Look at their success ratios, and evaluate the companies previously valued by them and the current position of those companies.
While there is no given matrix to help one arrive at the right valuation partner, a good look at their past performances and market reputation are two good benchmarks to rate them on suitability for your organization.
What tips the scale in favour of investment banks is the minimal chance of rejection, as they are equipped to consider both valuation and funding. Thus, this requirement becomes prominent when selecting a valuation-only agency.
To validate the accuracy of the valuation mark provided by the agency or the investment bank, SMEs can undertake a valuation analysis–comparing their valuation number with other SMEs in the same space, segment, and size who have raised funds in the recent past.
The next check the SMEs can undertake is to validate if the numbers arrived at by the agency/bank aligns with their past and present business performances to reflect a realistic future number.
Conclusion
Raising funds to accelerate growth is a given. SMEs should tread the path with open eyes. Being ambitious is good, but it needs to be tempered with an accommodative mindset. Choosing the right valuation partner is the first step in the journey, and the next is to remember why funding is sought and what goal it will help achieve. Remembering the timeliness of fundraising is crucial to maximizing opportunity conversion.
(The author is Mr. Shrikant Goyal, Co-Founding Member & Managing Partner, GETFIVE and the views expressed in this article are his own)
