If you are a business owner, you have undoubtedly wondered how much longer we will face this global pandemic. You have probably also wondered, “What is the effect of COVID-19 on business valuations?” The short answer is: It depends. Here are some more details to help explain the effect of COVID-19 on business valuations:
How will COVID-19 affect business valuations?
The effect on valuations from COVID-19 can vary drastically. Depending on the valuation date, COVID-19 may not be considered at all.
“Known or Knowable”
The timing and purpose of a business valuation is the first key in determining whether or not COVID-19 has any effect on a business’s value. Valuation standards set forth by the American Institute of Certified Public Accountants (AICPA) express that valuations ought to consider facts and circumstances that are reasonably known or knowable as of, and leading up to, the valuation date. Many believe COVID-19 was “known or knowable” in the United States by mid-February. So, it could be argued that any valuation dated before mid-February 2020 does not need to consider the effects of COVID-19 because it was not yet known or knowable.
However, this still leaves us with some ambiguity about when exactly COVID-19 was known or knowable. Comparing a valuation dated December 31, 2019 to one dated March 31, 2020 will be clearly and dramatically different. But, suffice it to say, for valuations dated in February 2020 and March 2020, you can expect the issue of “known or knowable” to be a point of intense debate.
The next question involves the purpose of the valuation and the integrity of whether to include or exclude COVID-19 impacts, even if the valuation dated before COVID-19 was “known or knowable.” Generally speaking, it is preferable to incorporate real-world events into valuations. For better or worse, COVID-19 is one such event. This means, depending on the context of the valuation, even if COVID-19 was not officially “known or knowable,” the disclosure of it as a “subsequent event” may be warranted.
For example, AICPA standards state that “in situations in which a valuation is meaningful to the intended user beyond the valuation date, the events may be of such nature and significance as to warrant disclosure in a separate section of the report in order to keep users informed.” With that in mind, additional analysis, and explanation of the impact of COVID-19 on a company’s value and performance may become part of the business valuation, regardless of the valuation date.
What is the effect of COVID-19 on business valuations?
Different valuation methods will require different considerations and adjustments to account for the effect of COVID-19.
The Discounted Cash Flow (DCF) method is an income-based valuation method that determines a company’s value by considering the business’s projected cash flow and then partially discounting that number to account for risk. As the current period of economic uncertainty continues, all valuation methods will be challenging, but this model is well-suited for making forecast adjustments. For example, a multi-period DCF would allow for annual projections over several years into the future. This means an analyst can model future years individually as a business stabilizes and returns to more “normal” operations over time.
Market-based valuations determine the value of a company by comparing it to similar businesses that have sold. The Market Method already includes the challenge of sufficient access to market data on sufficiently comparable competitors; now, it carries the distinct challenge of using pre-COVID-19 transactions in post-COVID-19 valuations. This means expert analysis and adjustments will be required in order to produce useful financial metrics. Simply gathering a group of transactions from the past three years and calculating an average multiple will not suffice.
While multiple valuation methods should always be used to value a business, some will be more appropriate in the time of COVID-19 and should be weighted accordingly. Truth be told, accurately valuing your own business is nearly impossible in even the simplest of times. At a time like this, more than ever, find a professional analyst to assist with your business valuation. You want someone who has the experience required to navigate the unpredictability of the current economy and will expertly consider COVID-19’s effect on valuations.
Request a custom valuation of your business today for the most accurate picture of your business’s value.