Business Valuations Amid The COVID-19 Pandemic – Why, When And How?

Why should I bother having my business valued – particularly now?

Whatever the size of your business and wherever you are in the life cycle of a business, understanding the value of (and the drivers of value) for your business is key to effective decision-making. Even in this volatile economy it is essential to understand the drivers of value when considering both short term and longer term planning.

Once a business has been valued, and the factors influencing the valuation are understood, the business owner can focus on strategies which will enhance the value. These strategies are not always the obvious ones. There will be opportunities arising out of the pandemic which business owners and their advisers will need to be ready to assess and act upon.

Situations where a business owner ‘must have’ a business valuation include:

– As part of a buy/sell agreement

– Raising funds from a bank or external investors

– Setting up an employee share scheme

– Valuations required for tax reporting e.g. probate

– Insurance claims such as for business interruption

– Shareholder and commercial disputes

– Divorce

Occasions where a valuation is ‘advisable’ include:

– In assessing a speculative approach to buy the business

– Assessing how to increase the value of a business or an investment opportunity

– In considering how a change or restructuring of the business will impact its valuation

– Succession planning

– Planning for retirement, an exit or acquisition

– Quantifying business and life insurance needs

– Estate planning

– Key person planning and incentivisation

Business valuation in a volatile economy such as now

Valuing businesses in normal times can be a challenging task as there are numerous internal and external factors that can influence business value. However, there has never been a more challenging time than now for a valuation expert to give a reasoned opinion on the value of a private company or unincorporated business. Valuing businesses is both a science and an art. In volatile times valuation becomes even more complex. Some would say that the “artistic input” into the valuation process is inevitably increased. We would also say it is even more important for past commercial experience of times of volatility and change to be brought to bear.

Modelling projected future cash flows

The valuation of an interest in a private company is based on the future economic benefits that an investor might expect to receive. The valuer will value the business at the given date based on what is foreseeable or reasonably foreseeable at the effective date of the valuation. Typically, in valuing trading businesses we are assessing future cash flows based on past performance and well founded and supported projections. The challenge for valuers at this point in the pandemic is that there is significant uncertainty about the extent to which historic data can be used to guide the valuer in assessing their future expectations about the business. In other words, the recent past may not be a reliable guide to the future.

Every business will be different and the impact of both the pandemic and the inevitable global slowdown will be different. Some business sectors may bounce back quicker and, in some sectors and businesses, the value may increase as a result of the pandemic. The debt structure of the business post pandemic will also be relevant to its value.

Potential adjustments as a result of the pandemic

In estimating projected future earnings/cash flows based on past performance there are numerous adjustments to the accounting information that may need to be considered as a result of the pandemic and/or the global slowdown. These could include:

– Loss of significant customers

– Loss of suppliers

– The impact on labour resource

– Regulatory changes

– Cancelled contracts

– Facility closures and supply interruptions

– Changes to customer buying habits

– Exceptional costs

– Tax changes

– Government interventions

– Changes to financial reporting legislation

– Impact of changes to funding sources and possibly banking covenants

In looking forward, business projections will also need to adopt balanced and reasoned assumptions in respect of these and other likely future variables. In some businesses retraction could protect profits – in others, that de-scaling may not be possible.

In all cases the valuer will need to consider the variables carefully.

Investor required rate of return or valuation multiple

In addition to projecting cash flows, the valuer also needs to assess the rate of return that an investor will require on the investment (the discount rate) or the valuation multiple that should be applied to future maintainable profits. If there is greater uncertainty about the returns, the discount rate will increase or the multiple might reduce – thereby reducing the assessment of value.

Because valuation multiples are a function of quality, risk and return, it is likely that in the post pandemic world, transaction structures may also become more complicated – with heavier reliance on “earn-out” structures laying off the risk taken by the acquirer. This will also need to be taken into consideration by the valuer.

Comparable transactions and data

A further input typically used in arriving at private company valuation is the multiples achieved in prior transactions in comparable businesses or sectors. At JDC Corporate Finance we draw from our direct involvement in real-life corporate finance transactions as well as published data and the experience of our experts in Walton Dodge Forensic who have completed over 2,000 business valuations. If the economy slows down, we may see significantly less acquisition activity and potentially larger discounts for marketability as a result of a smaller pool of buyers and sellers.  On the flip side, there may well be necessary consolidation of activities in certain sectors which will help protect deal flow, but will further complicate valuation comparators. It awaits to be seen how the banks’ appetite for lending will influence deal flow.

Asset based valuation methodology

Whilst trading businesses are typically valued based on future maintainable earnings (cash flows) and with a reference to recent transactions, in a challenging economy where the business may be trading at a loss the valuer may need to place greater emphasis on an asset valuation approach or adopt an approach based on more than one methodology – a hybrid valuation methodology.  During the current crisis the value of some of a company’s assets (e.g. property) may have reduced, whilst others (working capital in the form of cash, debtors, stock, etc) may be lower as a result of losses. Provision for foreseeable and unavoidable future short term losses may also impact on perceived asset value at a single point in time.

Conclusion

An independent valuation by a professional valuer is important as business owners inevitably have preconceived ideas of what their business is worth. The experienced business valuer will get under the skin of the business to understand the strengths and weaknesses of the business. They will also draw from their experience of transactions and trends in the sector.

Business values can, in our experience, change very quickly due to factors out of the control of the business owner such as this pandemic as well as ill-health, financial failure of a key customer or supplier, legislative changes or funders withdrawing.

Once a business has been valued, and the factors influencing the valuation are understood, the business owner can focus on strategies which will enhance the value. A business valuation can form part of a strategic review. In conducting strategic reviews, we work alongside clients to identify and implement the strategic options that will generate a sustainable increase in profits and ultimately maximise shareholder value.