Why Small Businesses Often Look “Riskier” in Court: The Truth About Size Premiums

When a business is being valued in a family law dispute, one question often causes confusion and disagreement:

Why does a smaller business sometimes end up with a lower value than expected?

For many clients, this feels unfair. You may have spent years building your business, only to see it discounted because of its size.

What sits behind this outcome is something called a size premium, a concept that plays a critical role in business valuations but is rarely explained clearly outside professional circles.

What Is a Size Premium?

A size premium is an adjustment made in a business valuation to reflect the additional risks associated with smaller businesses.

In simple terms, valuers often assume that:

• Smaller businesses are harder to sell

• They rely more heavily on a few key people

• Their income can be less stable

• They are more exposed to economic shocks

Because of this, investors typically expect a higher return when investing in smaller businesses.

That higher expected return translates into a lower valuation.

Why Smaller Businesses Are Seen as Riskier

Research shows that smaller companies tend to experience more volatile performance and higher uncertainty compared to larger businesses.

This does not mean they are poorly run. It reflects structural realities, including:

Limited diversification

A small business may rely on a few clients or a single revenue stream.

Key person risk

If one owner or employee leaves, the impact can be significant.

Lower liquidity

It is often harder to sell a small private business compared to a large company.

These factors combine to increase perceived risk, which directly affects valuation outcomes.

How Size Premiums Affect Business Value

In a valuation, risk is reflected in the discount rate used to assess future earnings.

When a size premium is applied, it increases this discount rate.

Even a small increase can have a large impact. For example:

• A higher discount rate reduces the present value of future earnings

• This leads to a lower overall business valuation

In Australia, size premiums are often applied in the range of 1.5 percent to 5 percent, depending on the size of the business.

This can materially change the outcome of a property settlement.

Why Size Premiums Are Often Disputed

Size premiums are not always straightforward.

Research shows mixed results. While smaller firms can generate higher returns, this is not consistent across all markets or time periods.

This creates tension in family law matters:

• One party may argue the premium is justified due to risk

• The other may argue it unfairly reduces value

The reality is that size is often acting as a proxy for multiple underlying risks, such as liquidity or financial uncertainty.

The Role of Forensic Accounting

This is where experienced forensic accountants make a real difference.

At DB Forensic, we do not simply apply a standard percentage and move on.

We:

• Analyse the actual risks specific to the business

• Separate genuine risk factors from assumptions

• Assess whether a size premium is appropriate and reasonable

• Provide clear, defensible explanations for court

In many cases, the key issue is not whether a size premium exists, but whether it has been applied correctly.

Need Clarity on Your Business Valuation?

If you are involved in a family law matter and your business value is being questioned, it is critical to understand how adjustments like size premiums are being applied.

DB Forensic can help you unpack the assumptions, challenge incorrect valuations, and ensure the financial evidence reflects the true position.

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