The COVID-19 pandemic has created many challenges for Chicago businesses. The shock of forced closures and stay at home orders have given way to new reopening guidelines featuring safety protocols designed to protect both employees and customers. All of these changes have forced businesses to adjust in order to serve their clients/customers and thrive in this new normal. COVID-19 has also impacted how business valuations are compiled, including how cash flow, risk premium, and other variables are determined. Since business owners continue to need valuations for mergers and acquisitions, divorce, tax, and other purposes, it is critical to understand how the pandemic will impact business valuations. To help clients, prospects, and others, Selden Fox has provided a summary of key considerations below.
Company-Specific Risk Factors
The pandemic has impacted how risk factors are identified and applied to the valuation analysis. Unlike past years, it is not reasonable to believe risk premium can be evenly applied to all businesses. The impact of COVID-19 varies significantly across businesses, industries, geography, adaptability, and financial position, including outstanding debt. It is important to consider the confluence of various factors to determine potential risks. For example, manufacturing companies must consider the possibility of supply chain disruptions, especially when relying on international suppliers. Brick and mortar stores may spend the rest of the year trying to manage or adapting. These examples illustrate how important the proper assessment of risk factors and the impact on cash flows is in the valuation process.
Past Performance No Longer a Good Indicator
Many types of valuations rely on the Capitalization of Cash Flow Method, relying on economic performance over a past period to estimate “normal” performance. The performance estimate is used assuming the conditions will continue over the long term. Unfortunately, given current conditions as a result of COVID past performance is not a reliable indicator for the near future. There is certainly a sentiment that consumers want things to “return to normal” sooner rather than later. How business valuations use past performance data will need to change to adequately determine company value.
Heightened Importance of Cash Flow
Cash flow is an important metric used to determine a company’s ability to continue operations. Given the drastic changes created by the pandemic a careful and detailed assessment of cash flow takes on a heightened level of importance. Evaluating the assumptions and judgments used when making cash flow projections are even more important. The valuation process will pay careful attention to these variables when determining expected future performance. This will provide important insight into how long a company can survive and whether it can thrive under current economic conditions.
Reliance on Economic Stimulus Programs
For business valuations covering the time period after COVID-19 arrived, it is important to understand how federal loan programs, tax incentives, and other benefits have been leveraged to alleviate financial pressure. As part of the process, the management interview will likely include questions to determine reliance on these stimulus programs. At a minimum, it is important to understand the types of benefits received, dates when received, the dollar value of each benefit, how they will be used, and how their impact is expected to impact the business. The details for each company will be different, and this information is necessary to understand the risk profile and impact on future cash flows.
There have been many changes in how business valuations are determined due to COVID-19. Many of the traditional processes will be modified to ensure an accurate value is determined regardless of the method used. If you have questions about the information outlined above or need assistance with a valuation for your company, Selden Fox can help. For additional information call us at 630.954.1400 or click here to contact us. We look forward to speaking with you soon.