COVID-19 has impacted businesses differently, depending on industry and pre-pandemic approach. For some companies, it has opened up new opportunities and accelerated revenue. For others, the business pipeline has slowed. Some have completely revamped their business model in order to survive.
It is difficult to articulate the full impact of the pandemic because so much is still unknown. Only time will tell the full extent of the virus’ economic and social impacts on businesses and communities. These challenges and adaptations, as well as the public health and economic factors that created them, all play a part in determining the underlying value of a business.
Valuations, by their very nature, are based on projections and estimates. Future expected earnings is the first and foremost factor that drives business value. When assessing COVID-19’s impact on a business, there are two sets of considerations that play a key role: macroeconomic and business-specific.
Valuation Considerations: Macroeconomic and Business-Specific
Even though the value of a private company does not fluctuate with the same volatility as public markets, it is impacted alongside business profits, business risks, financing markets and overall supply and demand.
On the spectrum of short-term liquidity impact and profitability impact for 2020, where does your industry fall? For businesses that are liquid with adequate working capital, a relatively good market position, no plan to disrupt infrastructure and little or no ramp-up time to return to normal, the value impairment would be non-material, although there may be some additional market risk.
On the other hand, businesses that shut down or significantly restructured the workforce or faced working capital challenges may see higher levels of value impairment. The exact level depends on cash flow levels and how long it takes to bring the company back to normalcy. In cases such as these, the valuator will be looking at the extent of impact, what has been the most significant factor and ways to mitigate risk moving forward.
COVID-19 Uncertainty and the Impact on Valuation Mechanics
Investors and valuators alike put a premium on stability and predictability of cash flows. After all, value is a function of normalized future income. Adjustments will likely be necessary to normalize profitability and account for the sustainability of business lines and future cash flow expectations.
The required rate of return applicable to most business valuations is either the weighted average cost of capital or capitalization rate. Given the current market turmoil, market inputs can yield materially different values over time. Valuators must assess actual versus perceived risk and the required investment return to achieve profitability. As the pandemic continues, we will learn if the past is really reflective of the future.
Strategies to Defend Business Value
The value of many businesses will be negatively affected by the COVID-19 crisis, but there will be a spectrum of impact. At one end, a decline in value could be minor and temporary, while for others, it could be major and permanent. Where a business falls along that spectrum will depend on the ongoing assessment of a number of factors, including sustainability of revenue stream, viability of the business model and an uninterrupted supply chain.
Business owners may be monitoring the changing value of their interests in relation to their overall net worth, which makes now an ideal time to take stock of operations and goals in both the near and long-term. Consider the following next steps:
- Get clear on overall goals: Have a thorough understanding of personal and business long-term goals, objectives, mission and vision
- Clean up financial practices: Think carefully before continuing to treat the business like a personal piggy bank. Forecasting will become more important than ever to get a more robust understanding of the company’s actual
- Identify risk factors: Assess internal availability of resources and develop a risk mitigation plan to address weaknesses.
As owners and executives continue to navigate the challenges brought on by the pandemic and defend the value of their businesses, the best approach is to stay calm and assess the needs of the marketplace and the supply chain. RKL’s team of highly credentialed valuation specialists – the deepest bench in the region – has decades of experience delivering fair and professional business appraisals. Need more information or ready to get started? Contact your RKL advisor or reach out using the form below.