Timing and Methodology Matters with a Business Valuation

Like nearly every other area of business, COVID-19 has impacted business valuations as some American companies have seen revenues plunge and future projections become uncertain. For business owners seeking a business valuation today, several complications introduced by COVID-19 may affect the outcome.

Why Do You Need a Business Valuation?

As you go into a business valuation at this time, two questions should be considered:

Why are you seeking a valuation, and why do it during the COVID-19 crisis?

Consider the reason you need a business valuation. If you have an event coming up in the next year – business exit, a divorce, change in partnership, a merger – COVID-19 may have a significant impact on your valuation, depending on your industry.

But if you are looking out over several years – perhaps this is a “benchmark” business valuation tied to your long-term exit plan – and your business is in an industry that is not one of those hardest hit by COVID-19, your valuation may not show much, or any, effect from the pandemic.

Methodology Matters

There are several different methods of performing a business valuation, and the choice of method should be appropriate to your specific business, your industry, and your reasons for obtaining a valuation. Generally, business valuations are based upon one of three approaches: the income, market, and cost (or asset) approaches.

In the COVID-19 environment, greater emphasis is being placed on the discounted cash flow (DCF) method of valuation, which is a variation of the income method that provides a risk-adjusted discount rate. There are several different methods of valuing businesses and some methods are more appropriate for certain industries and types of businesses than others. It’s important to understand which method is best for your business and discuss with your valuation professional the method that will be used.

The key in DCF analysis is the development of projections that reflect COVID-19-related impacts, including expectations over the long term. Valuation professionals exercise significant judgment when utilizing DCF analysis, heavily informed by management perspectives as to the company’s long-term outlook. To the extent the long-term outlook is affected by COVID-19, so will the analysis be affected.

Economic Considerations

All businesses operate within the context of the national and international economy. When a recession hits, such as the current one triggered by the COVID-19 pandemic, some businesses and industries are hit harder than others. Not all businesses have suffered during the current recession; in fact, some have thrived. So, the fundamental conditions for those businesses, including financial health and operating outlook, will be different than for other businesses and will be considered in a valuation analysis.

Some businesses may have experienced a decline in values during the COVID-19 crisis, attributable to many causes:

  • Revenues may have decreased due to government-mandated closures or declines in customer demand.
  • Some businesses may have experienced increases in debt – and therefore interest expenses – to pay employees and other fixed costs. Carrying this debt on the balance sheet will impact the valuation.
  • Decreases in asset values for companies such as real estate holding companies or a company holding investments in private and publicly traded equity. This can impact real estate assets due to lower rental and occupancy rates related to COVID-19.
  • The outlook for near-future operating revenues has suffered because of global supply chain disruptions or a decline in customer demand.

Unfortunately, COVID-19 has severely shaken the U.S. economy, as well as certain industries. Many businesses may never recover; those that had strong balance sheets going into the crisis will likely recover but may find their cash flow projections and future revenue outlook negatively impacted because of weaknesses in their customer base.

Even a strong business may find that a higher discount rate due to COVID-19 may reduce its valuation. While the business may be on solid footing, its customers may not be, and that impacts the company’s risk profile, in turn affecting the business valuation.

Additionally, discounts for lack of marketability may be factored into a business valuation due to the fact that transactions have decreased in some industries during the COVID-19 era.

Business valuations can be impacted by any recession or widespread disaster, and this one is no different. Moreover, a business valuation that you have received within the last year may no longer be accepted by a potential buyer because of changes in your marketplace due to COVID-19.

If you are considering a business valuation, contact your Barnes Wendling advisor for a discussion with our business valuation team.

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