How does COVID-19 impact business valuations?


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How does COVID-19 impact business valuations?

COVID-19’s global spread has affected businesses worldwide, dramatically reducing or even completely stopping business outputs amid an unprecedented demand and supply shock. Growing uncertainty within global markets may drive business owners to evaluate the future of their own business and may turn to conducting valuations on their own businesses to determine their current value. But is now the right time?

With individuals and businesses coming to terms with a potential “new normal” post-COVID-19, business owners have begun to determine how much of an impact COVID-19 has had on their business. One problem that has arisen for business owners is how to value their business, be it for tax purposes or an eventual sale of a business to an interested party.

The valuation industry has seen a dramatic impact in recent months as business sales transactions that have originally been in process have fallen through or been delayed prior to settlement. The dramatic fall in global equities during the months of February and March also sheds insight into investor mentality and how sophisticated investors have adjusted their financial projections amid the significant demand and supply shocks rippling through the global markets.

During these uncertain times, business owners should keep in mind the following points regarding their business if a valuation is required to make sure that they are making decisions based on sound information.

Timing and purpose for valuation

Business owners should consider the reasoning behind needing a business valuation, as the timing and purpose of the valuation may affect the proposed value of the business. In an ideal scenario, parties to a business sale transaction would seek to determine the fair market value of a business through an orderly arm’s length transaction, with both parties free of any pressure to buy or sell. However, given the current COVID-19 situation, calculating the fair market value may be difficult to determine as there may be no “market” to sell the business to, considering the minimal amount of business sale transactions occurring. Sales being conducted in the current market may be seen as “forced sale” transactions, attracting a “forced sale” valuation, which may significantly undervalue the fair market value of the business.

Business owners and their advisors must evaluate the time frame that a valuation is needed to prevent any undervaluation of the business.

Type of business

A common theme among business owners is the notion that the enormous demand fall-off for goods and services within the hardest-hit industries, e.g. tourism, consumer discretionary and hospitality, will result in a lower market valuation for these businesses. While businesses in these industries will most likely under perform in the short term compared to the rest of the market, prudent investors will take into account the future maintainable earnings of the businesses post-COVID-19 as well as the individual businesses’ financial position, including its debt profile, as these factors will inevitably dictate the fair market value of the business. A business with a strong balance sheet and minimal debt will be able to weather the COVID-19 storm far better than a business which is highly leveraged, despite being in the same industry.

Business owners seeking valuations on businesses in these hardest-hit industries must keep an eye on their expenses during these times to normalise the future maintainable earnings of the business once the COVID-19 effects on the business have subsided.

Methodologies for valuation

Short term impacts on a business will not have a material effect on the value, as these impacts would be allowed for and adjusted.  However, some business sectors (particularly those in travel and hospitality, for example) are expected to have some longer-term impacts and it would be appropriate to consider how these businesses should be valued.

Most established businesses pre-COVID-19 would be expected to have their enterprise value determined as a multiple of their historical earnings. Currently, this method for valuation purposes would likely overestimate the valuation of the business given that their prior historic earnings would not be reflective of their future earnings in this current environment.

Other valuation methodologies may need to be employed in circumstances like these, such as using an income-based valuation method (such as the discounted cash flow method). However, a significant drawback of this method is that small businesses usually do not prepare detailed cash flow forecasts on a multi-year basis, with the extent of many budgets only being forecasted for one year or less.

Business owners who are interested in valuing their business should seek to perform long term forecasts on their business’s financial performance and adjust for the COVID-19 effects on the business in the short term.  This is also a great opportunity for business owners to sit down with their accountants and advisors, and really think and plan their future!

If you would like to know more and find out what options you might have, please contact Suelen McCallum at dVT Group on 02 9633 3333, or by email mail@dvtgroup.com.au

dVT Group is a business advisory firm that specialises in business turnaround, insolvency (both corporate and personal), business valuations and business strategy support.