Even in "normal" times, business valuation is an exercise that is part quantitative and part qualitative. Only after years of practicing is the valuator competent enough to know which portion of each should be applied to a specific case. And the along came COVID-19 to further complicate the process.
For the most part, COVID has a direct impact on business value; not all current valuations result in fewer values, as some firms have done exceedingly well. The critical question to answer is how to account for COVID, and for how long. The following are the key factors we consider in our analysis:
- For valuations as of December 31, 2019, COVID is not a factor. We did not know then about this pandemic.
- A capitalization of income approach is a static formula used in lieu of discounted cash flows (when client does not provide these projections). The metric is an average net income divided by a capitalization rate. Generally, this technique should not be applied to a COVID valuation, since it cannot properly account for the current environment versus the expected return to "normal period."
- Our clients provide us initial cash flow projections for the next three to five years. To account for the impact(s) of COVID, we temper the expected cash flow for the next year or two; this assumes that the business will return to somewhat normal conditions after this COVID period.
- We carefully dissect cash flow assumptions provided by our clients, including top line revenues by product line. Was there a pivot in product/service offerings? What changes have occurred in margins, both gross and net? Have operations changes been reflected in these margin estimates? How quickly were unnecessary expenses reduced or removed?
- In normal times, another useful approach to estimate value is to assess sales of similar, comparable companies. From these sales, we derive a reasonable multiple to apply to the company's EBITDA. During the COVID era, it is difficult to determine appropriate multiples. Thus, we place less weight and significance on these sales of comparable businesses.