The COVID-19 pandemic has changed the way everyone views value in business. The pandemic and its subsequent lockdowns have shaken up global markets and disrupted businesses in nearly every corner of the world. This has led to heightened concerns about fairly valuing companies, resulting in more regulatory and stakeholder scrutiny.
The sectors most impacted by pandemic have been travel, leisure, energy, and resources, largely in part due to lockdowns and travel restrictions. At the same time, the sectors least impacted include consumer essentials, information technology, and common equipment. Companies in less affected sectors will face fewer challenges in getting an accurate business valuation.
For many companies, COVID-19 has acted as a catalyst for change, forcing businesses to adapt and innovate in new ways. In many cases, the changes will be lasting improvements, such as strong digital strategies, more diverse suppliers, and streamlined processes. Many businesses have taken this time to reassess legal issues such as asset protection and operational enhancements. Taking these types of measures can add significant value, positioning some companies for a bright future as a result.
Another interesting development has been around the Chicago Board Options Exchange's CBOE Volatility Index (VIX), a common measure of the stock market's volatility expectations based on S&P 500 index options. During the pandemic, the VIX shot up from 15% to 80% before settling at around 30%. That’s double the level of pre-COVID markets. This level of volatility has also been mirrored in global markets. A company cannot simply ignore recent declines in their stock price. It indicates factors that the company must consider, such as specific parts of the business that have been affected and how it affects the company overall.
So what do we need to look at when valuing a business in the post-pandemic environment? Many businesses already have an understanding of the short-term impacts of community lockdowns and slowed in-person business. In many cases, earnings forecasts will need to be projected downwards. But adjusting cash-flow forecasts requires a balance of possible negative scenarios with other inputs in the valuation formula to avoid double discounting the valuation. Cash balance and the cash usage rate must be used to assess the company’s ability to continue to operate. This includes any changes the business made to preserve capital during the pandemic, as well as its longer-term prospects and risks. We also must craft a range of scenarios for forecasting recovery based on lessons learned during the pandemic, in addition to market trends and forecasts. The short, medium and long-term impacts of the crisis need to be considered. Market disruptions can be temporary, so any adjustments could overstate or understate the pandemic’s impact on the business’s valuation.
There are three standard business valuation methods used: the income method, the market method, and the asset method. Multiple methods are always used to valuate a business, but COVID-19 has caused certain methods to make a bit more sense than others. For example, under the income method of Discounted Cash Flows (DCF), the company’s future financial performance is projected over a period of years and partially discounted based on risk. Under the income method of Capitalization of Cash Flows (CCF), a single income stream is chosen (typically based on historical results) to project future income. The pandemic has caused economic disruptions that may make DCF more useful in trying to predict the future performance of a company because it allows future years to be modeled individually as operations return to normal over time. However, some find this method to be unreliable, and it may still face challenges if uncertainty persists, and multiple scenarios may be needed to model a company’s performance over the next one to two years.
The market method of valuations determines value by comparing it to similar businesses that have been acquired (oftentimes public companies on the stock market). This method already relies on market data regarding sufficiently comparable competitors and how comparable they actually are based on factors such as size, profitability and growth. Now it comes with the challenge of using pre-COVID-19 transaction data in post-COVID-19 valuations, requiring adjustments to produce financial metrics that are relevant and useful. Plus, it needs to be taken into account if the business or its competitors have received any COVID-relief government funding.
Under the asset method, the value of the assets and liabilities of the business are restated to current market values, deducting the resulting value of total liabilities from total assets to arrive at the net asset value. This approach also needs to factor in whether there are any unrecorded assets and liabilities. This method is often considered to be inappropriate for valuing service-oriented businesses, something that the COVID-19 pandemic has made even more complicated, especially when comparing anything to current market values that may be entirely upended during these times.
Valuing a company is a challenging undertaking even when there is not a pandemic. When applying any valuation methods, additional considerations and adjustments will need to be made because of the pandemic. The goal of any business owner seeking company valuation is to use the most useful financial metrics based on the company’s circumstances. During these times, it is just not as simple as gathering a group of transactions from prior years to calculate an average, as would commonly be done in the past. The market method will likely need further analysis and adjustments when it comes to using pre-COVID numbers in post-COVID valuations. If you are seeking a company valuation for your business, seeking professional expertise can go a long way in getting you the value you deserve, in these times more than ever. Intimate knowledge of the business and the sector combined with valuation experience and appropriately managed expectations can go a long way in arriving at a more accurate valuation, especially in these continually evolving times.