Business Valuations during the “New Normal”: The Impact of COVID-19

Due to the precautions to limit and slow down the spread of the novel coronavirus 2019 (COVID-19), many small businesses have experienced some level of decline in their operations. But echoed within the PPP Application Form, Congress does not consider all small businesses to be negatively impacted. This is evidenced by the certification requirement that “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Some examples of industries that may not be impacted include grocery stores, pharmacies, and FedEx operators, to name a few. But for the majority of businesses that have been affected, this article will address some of the most common questions surrounding the impact of COVID-19 on business valuations.

When does the impact of COVID-19 get taken into consideration in a valuation?

To answer this question, you first have to understand the difference between a valuation date (also known as the effective date) and a report date. The valuation date is based on the operations of the business as of a certain point in time (similar to how a balance sheet is a snapshot of a company’s assets/liabilities), while the report date is the date the appraiser completes the report.

The AICPA’s Statements on Standards for Valuation Services (in parity with NACVA’s Professional Standards) states the following: “Generally, the valuation analyst should consider only circumstances existing at the valuation date and events occurring up to the valuation date.”

Based on the statement above, appraisers should only take into consideration the facts known (or knowable) up to the valuation date. As an example, let’s consider an appraiser is performing a business valuation as of 12/31/2019 (valuation date), but doesn’t complete the report until 3/21/2020 (report date). Although the appraiser may have known COVID-19 would materially impact the business on the report date, the effects should not be taken into consideration in the valuation as these facts were not known as of the valuation date.

Under the recent CARES Act, Congress defines an “impacted borrower” as one that was in operation on March 1, 2020. As of this date, there were considerable facts available regarding the spread/severity of the virus, along with movements in the stock market, to determine COVID-19 would have a foreseeable impact on small businesses. Using this as guidance, appraisers may consider utilizing a valuation date on or around March 1, 2020 to deem COVID-19’s impact applicable to the valuation.

A separate, but related question involves when a business valuation report expires. Although the SOP has remained silent on this topic, the SBA has confirmed business valuations must reflect an accurate value of the current business. Previously, the unwritten rule was that business valuations expire within 6-12 months of the application (in line with equipment and real estate appraisals). However, given the existing circumstances, it is prudent for lenders to request any recent business valuations be updated to reflect the impact of COVID-19 using a valuation date on or around March 1, 2020. Furthermore, the SBA has provided guidance to lenders on how to deal with 7(a) loans approved, but not yet closed, or loans that have not been fully disbursed, for businesses that may be impacted by COVID-19, available at the following link: SBA Procedural Notice 3/26/2020.

How are business valuation multiples impacted by COVID-19?

We can observe how market multiples were impacted during the last two recessionary periods (9/11: March – November 2001 and the more recent Great Recession: end of 2007 – mid 2009) to gauge their impact on valuation multiples. The below chart represents the median multiple for all industries extracted from the DealStats database (formerly Pratt’s Stats) from 2000 – the present:

As seen above, market multiples declined by approximately 15% from their pre-recessionary levels in each of the last two recessionary periods identified. Overall, we will likely expect business valuation multiples to display a similar trend as we move forward during the current economic climate caused by COVID-19. It is important however, to keep in mind that factors such as projected cash flow and company specific risk rates will have a higher impact on the final value of the company than the market multiples themselves.

What requirements are needed to consider COVID-19 in a valuation?

Prior to COVID-19, appraisers were able to rely on a Single Period Capitalization method, which is based on the assumption that a company’s historical operations were stable and moreover, a good indicator of stable future performance. Because of COVID-19’s negative expected impact on businesses, appraisers must now rely on the Multi-Period Discounted Cash Flow (DCF) method, which takes into consideration forecasts that go far out enough until a company’s operations stabilize (typically three to five years).

simplified example of the single period capitalization method and the multi-period DCF method are shown below, which reflect the value of a business before and after the impact of COVID-19 (all figures below are rounded):

Disclaimer: the information in the tables above are presented for simplicity purposes and are not intended to reflect a thorough representation of the Single Period Capitalization or Discounted Cash Flow models.

Once financial forecasts are obtained, it is important to vet the projections by assessing COVID-19’s overall impact on the business. Some key COVID-19 specific questions include (but are not limited to):

  • How do you expect COVID-19 to impact your future sales/operating results?
  • Was the Company’s operating location temporarily closed?
  • Does the Company have any significant contracts or purchase orders impacted by the effects of COVID-19?
  • Does the Company have any significant suppliers impacted by the effects of COVID-19?
  • Has the Company applied for any loan assistance programs (SBA Disaster Recovery, CARES ACT (Payroll Preservation Program)? If so, please describe any anticipated loan proceeds the Company received / is anticipated to receive.

While the current crisis is expected to have a negative impact initially on valuations and the economy in general, it is important to keep in mind that risk is largely based on uncertainty. As we continue to progress throughout the year and the uncertainties surrounding COVID-19 decline, so too should the overall risk rates that impact business valuations.

How are equipment appraisals affected?

The current environment, due to COVID-19, has presented a challenging situation for on-site equipment appraisals. Many of our clients are still requesting on-site machinery & equipment appraisals, however visiting a site location at this time may not be possible in some cases due to state and local restrictions.

The good news is that Reliant Equipment Appraisals is still able to provide a USPAP compliant Desktop Appraisal Report. We have partnered with one of the leading site inspection companies to offer a Desktop Equipment Appraisal with a Virtual Site Inspection. What this means is that Reliant Equipment Appraisals will work with the inspection company and business owner to virtually take photos of the equipment through the business owners’ smartphone. The photos will be time stamped and accompanied with a geotag so that you can be assured the assets are located as reported by your client.

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