As the coronavirus pandemic (COVID-19) continues to spread across the globe, markets are marked by uncertainty and extreme volatility. For many business owners and shareholders, this uncertainty is causing high levels of concern related to business valuations – especially in light of the high number of transactions and deals that are currently stalled for the foreseeable future.
This uncertainty is a stark contrast to the entire premise of business valuations, which are based on forward-looking projections based upon historical performance. COVID-19 presents a new set of circumstances for which there is little or no data. Taking this into consideration presents challenges to the current valuation process. There are several elements business owners should consider during this uncertain time.
Valuation Date
No matter what industry your business is in, there is simply no denying the valuation of a company will look far different in the middle of 2020 than it would have at the end of 2019. Identifying an optimal valuation date can serve several business advantages.
Although many companies didn’t feel the effects of COVID-19 until March or April, it’s still uncertain how long potential impacts will be felt. However, certain circumstances may find a business valuation calculated during an uncertain time to be advantageous, such as those done for estate and gifting purposes or “one side” of a divorce. Other companies may be able to defer valuations until a more normalized approach may be taken. Either way, it’s worth reflecting on the purpose of the valuation and selecting an optimal date.
Cash Flow
Cash flow, or the earnings stream that a business is expected to generate, is being negatively impacted due to COVID-19 for many businesses. The severity of this may vary depending upon the industry and area which the company serves, but many companies will either suffer temporary setbacks or permanent closures due to the inability to maintain adequate cash flow during this time.
From a valuation perspective, the anomalies seen during this year’s revenue and expenses will significantly deviate from historical patterns. Valuators will likely be aware of the surrounding circumstances and adjust accordingly to continue using a more normalized approach to forecasting models. However, the specific adjustments made may be more or less substantial depending upon the company itself and wether the effects of the pandemic on business linger or not.
Risk Profile
For many companies, inadequate cash flow may lead to a need to seek capital, which can change the amount of interest-bearing debt owed by the company. Additionally, there may be a general increase in risk-based upon how the events of the pandemic are likely to influence the company, given its operational strategies and geographical location.
The sum of these factors often leads to an entirely new risk profile, which must account for the ability of the company to assume additional debt and continue to attract revenue under new market conditions. However, risk has a direct impact on valuation, which means that business owners should consider their existing risk and how COVID-19 may change it.
Future Profitability
The reality is that COVID-19 is reshaping the market, and some companies will be positioned to thrive and succeed far better than others. Even now, at the height of the outbreak, some business models are far better suited to handle the changing circumstances than others. The impact of the pandemic on growth and earnings may be short, or it may be long-lasting – particularly if the attractiveness of the company wanes post-pandemic. Growth and profitability must be factored into any valuation, which means that owners should spend some time considering how the pandemic may have either positive or negative impacts on future prospects.
While maintaining personal health for yourself and your family is the top priority for most individuals during COVID-19, understanding how it may impact your business is next on the list. And as many businesses have encounter challenging times and even crises in the past, these may pale in comparison to the effects of this pandemic.
As a further challenge, it’s clear that we do not yet understand the full scope of effects and aftermath that many businesses will experience once the pandemic is over. However, knowing what factors COVID-19 is likely to impact your business and how those factors affect valuation is critical. This type of comprehensive understanding can help you to make better strategic decisions to guide you out of the pandemic and to future success.
Shuster & Company, PC offers an extensive range of services, with emphasis in forensic accounting, divorce consulting, business valuation, and litigation support. As a full-service Certified Public Accounting Firm located in Denver, we provide quality, personalized financial advice and guidance to individuals, businesses and the legal community.