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Explanation of discount adjustments

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We explain in our area of Business Valuation the adjustments that must be taken into account for a correct valuation and approximation to market reality. The most common are those of illiquidity and size.

Application of discount adjustments

When it comes to valuations, as we have previously mentioned in other articles, the valuation methods that are usually used when valuing companies are the DCF, multiples on past transactions and multiples of comparable companies.

These can be used to obtain a base valuation of the company. However, the assumptions on which these types of valuations are usually based are that the companies have a certain size or are very liquid, in other words, they can be sold easily at a reasonable market price and without great effort.

However, small and medium-sized companies and those that are not listed do not meet this type of assumption. This causes valuations to require certain discount adjustments to allow for a correct valuation and to be closer to market reality. The most common discount adjustments for this type of companies are those of illiquidity and those of size.

To get an idea, small or start-up companies usually have a scalability problem, i.e. it is usually necessary to make large investments to reach a certain size, be profitable or achieve an efficiency that makes them sustainable over time. In addition, it is usually easier to sell these companies once they reach a certain size.

For this reason, a common adjustment to the valuation is usually a valuation adjustment. size discount. This is usually applied to compensate for future investments that the investor will need to make to obtain a certain profitability or to achieve scalability and market or product development to ensure the company's sustainability.

There really is no specific type of discount adjustments applicable to all companies, but it is necessary to have a good knowledge of the sector and the type of business. Business Valuation.

However, a generally accepted figure is usually a size adjustment for companies with a turnover of less than 10M€. Normally, this adjustment may vary, but it is usually around 20% of the total valuation.

In addition, the other adjustment mentioned above, the illiquidity adjustment, must be taken into account. This adjustment, as its name anticipates, is the one that is made because of the relative difficulty of unwinding an investment. Normally, when companies are listed, due to the efficiency of the markets, an investor is able to sell his shares to a counterparty without having to trade, applying market prices.

However, when it comes to private companies, the difficulty usually lies in finding an investor, due to the size of the operation and the difficulty the latter will have in withdrawing the investment in the future when it wants to monetize it.

For this reason, due to the resources required, both monetary and human, to close this type of transaction, and the greater risk involved, since they do not have as much liquidity as listed companies, it is usual to perform a adjustment between 20 and 30% of the valuation.

In this case, the sector the company's sector also has a strong influence on the application or non-application of this adjustment, since there are certain sectors that may be more attractive to investors, facilitating future exits and reducing the discount applied, which is why having experts in the sector can help optimize negotiations.