Do smaller companies suffer from a higher cost of capital due to greater risk? Valuation analysts have been arguing about this so-called “size premium” for decades, kicked off by a 1981 paper by Rolf Banz (now a senior advisor at the London Business School).
And it doesn’t appear the conversation is getting any less heated. Recently, NYU professor Aswath Damodaran, known as the “dean of valuation,” opined that the size premium had “been gone for 40 years,” and advised analysts at a recent CFA Institute conference to “just let it go.”
Another well regarded valuation analyst, Clifford S. Ang, agreed, suggesting that the “evidence shows that there is no theoretical foundation for the size premium.” He further suggests that the size premium doesn’t distinguish between the risks faced by a “young small company” and an “old small company” and that using the size premium might even put an expert’s testimony at risk for a Daubert challenge.
Of course, other industry sages dispute these ideas, including valuation authority Roger Grabowski, who claims Ang’s analysis is misleading. Also, the widely used Annual Pepperdine Private Capital Market Report has consistently demonstrated the existence of a size premium.
While the academics debate, there seems to be far more consensus among valuation practitioners. A recent poll found that 94% use a size premium in their valuations. And it’s considered a best practice by credentialing organizations.
There’s no one-size-fits-all approach to valuation and there are plenty of other factors involved. What’s most important is partnering with experienced, credentialed valuation analysts like the Dembo Jones team for a comprehensive approach that fits your unique business position and need. Contact us today.