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Verified Knowledge
Ref: 01.03DCF: FOR STARTUPS, NOT BRICK & MORTAR
What is the DCF method and when to use it?
Official Position
The Discounted Cash Flow (DCF) method is standard for startups but often rejected for stable SMEs. It values a company based on projected future cash flows discounted back to today. In the pragmatic Swiss culture, relying on long-term forecasts is viewed with skepticism ('DCF stands for Dreams Come False').
### Technical Explanation
The DCF method is widely regarded in corporate finance theory as the most 'accurate' intrinsic valuation tool. However, in the Swiss SME market, its application is nuanced.
#### The Mechanics of DCF
The valuation is the sum of the present value of:
1. Projected Free Cash Flows (FCF): Explicit forecast of distributable cash for 5 to 7 years.
2. Terminal Value (TV): The value beyond the horizon, often accounting for 60-80% of total value. This makes the valuation sensitive to the assumed long-term growth rate.
#### The Problem with DCF for SMEs
For a traditional 'Brick & Mortar' SME, DCF is often viewed with skepticism by local banks. The method is highly sensitive: a 1% change in WACC can swing valuation by 20%. Buyers of stable SMEs prefer the certainty of historical EBITDA multiples.
#### When DCF is Essential
* Startups / High-Growth: For companies with negative current EBITDA but high potential (e.g., Biotech, SaaS).
* Finite Life Assets: Companies with a defined lifespan (e.g., quarries).
* M&A Pricing Validation: Sophisticated buyers run a DCF as a 'sanity check'.
Rationale & Context
Use DCF to justify the 'Growth Story' but settle on Multiples. If your company is about to launch a new product line or expand into the DACH region, historical multiples will undervalue you. In this specific case, run a DCF to demonstrate the future value of these initiatives to the buyer. We use the DCF to argue for an 'Earn-out'—telling the buyer, 'If you don't believe my forecasts, pay me the DCF value contingent on these results.'
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Legal Citations
- § Discounted Cash Flow (DCF) - Income Approach