WACC for a small business

Hi all,

Hoping I can get some help here. I need to do a valuation for a very small company. Its a consulting business that sources its clients/customers mostly through their website.

Anyway, I am intending on doing a DCF to value the company, but my biggest issue is calculation a WACC. Anyone got any ideas on how to do this?

Secondly, any other methods of valuing/supporting the valuation?

This valuation could be used for a venture capital funding perhaps or something akin.
Also, they are a profitable business.

 

I don't know jack sh*t, so hopefully someone else will chime in. But, in order to amuse myself/y'all and hopefully learn a thing or two, I'll take a stab at it anyway. Wouldn't use just want to do some free cash flow model (maybe that's the kind of DCF you're talking about)? Also, with regards to the required rate of return, can't you just use the risk free rate and tack on a few hundred basis points for risk?

 

You can't use a WACC on start up company typically because the cashflows are mostly guesses so your discount rate using WACC (would be way too low) would overvalue the company. I would recommend not using a DCF until positive EBITDA has been reached (not venture anymore) and you are fairly certain of future cashflows... Valuing a VC is very tricky and best done looking at comparable acquisitions in your sector on usually a Rev multiple (as they may not have positive EBITDA).

 

No i know how to caclulate it. Its just when its a small business, the market risk etc in my opinion should be very different to a public traded company, and as you say the liquidity risks, etc.

I think I have found some good ideas on it now, so thanks a lot guys.

May as well ask another quesiton here if anyone can answer. This small business owner is looking for funding, preferably debt, for something in the line of 150K. Anyone got any ideas on how to get that besides a bank?

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Best Response

Ballooshi, consider everything you know about the business incalibrating that level. Forget the CAPM formula for a moment, and put aside beta, Ke, and Kd.

Use discount rate as a proxy for true risk. What sort of risk factor would you put on this business?

Consider how long the company has been profitable, what its project length, recurring revenues, returning client rate, prospecting rate and all of those other critical factors are as you measure the risks.

Now think about returns. Is debt possible? What would that marginal rate of debt be? High most likely. But you don't have to be precise. Just estimate. It's almost certainly not 5%. Is it 8%? 10?12? Can you do any debt at all given no assets and unpredictable or nonexistent free cash flows? If the last, then WACC is Ke.

So what is Ke? Think about the returns froma real options perspective. There is a real chance your investment goes to $0. Is that a 1/3 chance? 50%?

What happens if everything goes well? There's a 2/3 chance it grows by 100% every year? But a 1/3 chance it goes to $0 in any year? You've just calculated your expected value from which to infer your Ke.

As a personal comment, knowing absolutely nothing about your company, I believe your discount rates should be coming out in the 30-40% range easily, and potentially higher.

 
GenghisKhan:
As a personal comment, knowing absolutely nothing about your company, I believe your discount rates should be coming out in the 30-40% range easily, and potentially higher.

Newb here, so can someone please explain to me why the discount rate is so high?

 

GenghisKhan is exactly right, wish i had a SB for him.....You could also just calculate normal WACC and then add a DLOM of about 30% (empirical studies) or calculate the DLOM using a Black Scholes put pricing model.

OP, what is the 150K going to be used for? That may help decide some options in raising the funds. Some small PE shops may be interested but you would likely have to have a nice interest rate and a convertibility feature in order to give some upside due to the venture risk.

 

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