The financial effects of COVID-19 on our society are ongoing, and the full effects may not be known for some time, but the damage to our society because of efforts to contain the pandemic and to our economy, with tens of millions out of work, are very clear and very real. As a business owner, we may be feeling immense pressure from multiple fronts to make tough decisions that will affect the lives of ourselves, our families, and our customers.
Decisions from business owners have to consider any number of factors, and one of the most critical questions to ask is “how have the effects of the COVID-19 pandemic impacted the value of my business?” There is a universe of uncertainty surrounding that question as global markets struggle to regain their equilibrium, cities cautiously begin to re-open, and people around the world try to find their way back to a semblance of normalcy.
How Do I Place A Price on The Value of My Business?
To understand the effects of COVID-19 on the value of our business, we first have to fully understand the underlying principles of business valuation. When considering the value of a business, one of three basic approaches will be used.
The Income Approach establishes a projection of the future value a buyer might expect to receive as a result of acquiring the business.
This value is determined by weighing these theoretical future earnings and the required rate of return for investing the business.
This offset of future revenue against immediate risk is inverse to the value of the business. The higher the rate of return, the lower the value of the business according to the income approach to valuation.
Because economic uncertainty is so high at this time, the value of businesses across the board has been driven down commensurately.
The Market Approach to business valuation looks outward at the selling prices of companies in the same space and uses EBITDA value metric, which stands for earnings before interest, tax, depreciation, and amortization using those “guideline companies” as the measuring stick against which the value of the company in question is measured.
This approach is problematic as it relates to valuation during the tumult of the COVID-19 pandemic and its effects. Any weight we assign to the historical data used will not accurately represent our current unprecedented economic landscape.
Also, the future EBITDA of a business cannot be reliably estimated by historical EBITDA data and will result in increased risk to an investor, thus driving down the value of the business in question.
The Asset Approach is used for valuation of businesses for whom their liquidation value is greater than the value of the business in operation as determined under the income, and market approaches.
This approach suggests that a buyer can expect a greater ROI if they liquidate the business’ physical assets after settling liabilities and closing up shop than they would by continuing business operations.
How Is COVID-19 Affecting Business Valuation?
In terms of owners who are considering selling their business, having weathered the pandemic may be less a choice and more of a necessity if they wish to close the sale. Because of the uncertainty driven by the current economic climate, buyers are skittish and may be constrained by lack of financing thanks to lenders who also feel doubtful about the economy, and likely to have much more stringent requirements in place to approve loans.
Some may believe that because their business did manage to remain viable throughout the hardships of the pandemic, it places a premium value on their business, reasoning that the stability of the business suggests longevity and lends to its value by virtue of the income approach. Unfortunately, this is not the case. Business valuations do not account for events that occur after the valuation date. Rather, a business valuation will consider only what was “known or knowable” at the time of the valuation.
This means that the valuation of the business will hinge on an understanding of the timeline of the COVID-19 pandemic. Prior to the first part of 2020, COVID’s impact would have been neither known, nor knowable. So, valuators will need to make their assessment based on a specific date, and what information was known and knowable as of that date. There must then be a determination of how much that information should be taken into account in considering the valuation of the business.
Cash Flow, COVID-19 & Business Valuation
Traditionally, cash flow has always been a key performance indicator when it comes to valuation based on a company’s projected ability to continue operations going forward. Because of the many unknowns associated with the coronavirus pandemic, a company’s cash balance and cash usage rate will be extremely important when valuating that business.
What Can I Do to Build the Value of My Company in The Age of COVID-19?
A company that can demonstrate concrete efforts made to lower costs and reduce spending throughout the crisis makes much more of an impact when determining how the company will survive as the situation persists than the simple fact of having survived the initial crisis in and of itself.
This consideration of longer-term projections of the company’s longevity will also factor into risk assessment during the income valuation approach and affect their discount rate, which is defined as the interest rate used to determine the present value of future cash flows in a discounted cash flow valuation analysis.
Be Patient, Remain Positive
COVID-19 continues to pose more questions to the business world than we currently have answers to. Whereas some will find themselves struggling to maintain the value of their business in the face of the coronavirus, others are thriving. Still others have pivoted their business models and are exploring new ways to get their products and services in front of the buying public. Where there is adversity, there will always be opportunity.
Business owners will need to weigh their goals for the sale of their business against the mercurial business landscape that COVID-19 continues to present to our society. For those who are bound and determined to sell their business, owners would be wise to remain poised to move quickly with the shifting of the tide and to stay informed regarding the trends that may signal the ideal time to sell their business for a maximum return.