As a business owner, you never operate in a bubble. Everything around you—your market, your supply chain, your employees, your customers—impacts your business.
This “everything-is-connected” concept has never been clearer than during the coronavirus pandemic. Worldwide, every business has been jolted—some in a positive way, but many in a dramatically negative way.
Yet, deals are getting done. Estate and gift planning continue. Valuations go on.
How do valuation analysts determine the value of a business or stock in such an unusual time? What factors do they consider? How does this affect your company’s value? As always, it depends and varies by situation.
Pandemic or not, valuation analysts must always understand the numbers and what’s behind them—how the target company is performing, which way the numbers are moving, how management is addressing business challenges, and the risks that affect the company’s cash flow, among other considerations.
Due to the pandemic, many of these numbers are currently off. No one knows how, when, or to what extent the economy will recover. We can assume that at some point, maybe next year, U.S. companies will be at a “new normal.” Cash flows will normalize, suppliers and customers will be back, workers will be employed, and the economy will be growing again.
But for now, valuation analysts—and business owners—have several truths to consider:
- Revenues for most businesses are down. Restaurants, salons, dry cleaners, tourism, travel, and similar “high-contact” businesses have been decimated over the past few months. Of course, there are exceptions, and some businesses are thriving. For example, grocery and big box stores that remained open have seen revenues soar. However, depending on their particular circumstances, their expenses may also have escalated.
- Debt is up. Many businesses continue to pay employees. While revenues declined, rent and other fixed costs did not. Some Paycheck Protection Program loans will need to be repaid.
- In some cases, asset value may have tanked. For many, inventory value sank dramatically.
A valuation may or may not reflect the impact of the pandemic because of the valuation date.
A valuation determines value on a particular point in time. Consider a valuation date of December 31, 2019. No one was talking about Coronavirus, and buyers and sellers would not have known what was ahead in terms of COVID. A March 31, 2020 valuation date might reflect an entirely different result, depending on the business.
Valuation reports typically include a discussion of what was “known and knowable” on the valuation date, and valuation analysts only consider the circumstances that were known up to that date. “Subsequent events” that affect value, like the pandemic, can also be discussed in the valuation report.
Cash Flow Risk
In valuation, cash flow equals value. With so much uncertainty, how can an analyst accurately assess future cash flow and risk to determine the discount rate? Some analysts are taking long and short views.
What is the impact of the pandemic on near-term cash flows? In certain industries, consumer demand might pick up right away. In others, the future is uncertain. Using a forward-looking discounted cash flow (DCF) method has the benefit of capturing assumptions that are relevant today. A DCF model can capture current restrictions, as well as potential recovery and post-recovery assumptions.
Discounts & Risk Premium
Discounts for lack of control (DLOC) and lack of marketability (DLOM) reduce value due to the absence of control or liquidity of the interest. Valuation analysts have options about where they reflect risk, whether in the cash flow stream, the discount rate, or in the DLOC or DLOM.
Risk due to the pandemic is likely to be reflected in cash flow. However, various analysts are taking different approaches. One veteran analyst reported that his team is adding a temporary 1% COVID risk premium in developing discount rates for now, but will “revisit the issue” frequently.
Does it make sense to buy or sell a company now? Many deals are on hold, and if the 2008 recession is a guide, it took a while for mergers and acquisitions to recover. It’s impossible to generalize about what is best for your company, but deals moving forward now are typically closing because of specific circumstances; they involve strategic buyers and synergies, and can be accomplished without significant financing.
Conversely, estate planning and gifting are likely to see an enormous uptick due to reduced business value. If you are considering transferring wealth to a younger generation, now’s the time. Additionally, many divorce cases involving valuation are stalled due to the courts being closed.
The pandemic has been painful for countless business owners. If it has been difficult for your company, you are not alone. The pandemic has also underscored the importance of having a trusted team of financial and business advisors to assist through these times. Wise counsel and expertise go a long way toward recovery. For this reason, it’s crucial to surround yourself with smart people who are looking out for you. If you are concerned about your business value, gather your team and brainstorm ways to manage or improve it.
If you are thinking of buying or selling a business, call on your advisors to weigh in. Discussion of the pandemic on business value will be a part of every valuation moving forward for the foreseeable future.
Finally, take a long view. Nothing lasts forever. As difficult as the pandemic has been, it has presented an opportunity for some business owners. Many have been forced to get creative with their products and services, pivoting to new or different offerings, and creating new income streams to survive. There is reason for hope.
We can help you create and determine value for your business. Please reach out to your trusted Mueller Prost advisor for support.