Time will tell what the long-term societal impact of COVID-19 will be, but it goes without saying that the past year will go down as one of the most unique and important in all of written history. With little warning, the novel coronavirus emerged on the scene in early 2020 and immediately made its presence known, wreaking havoc on the day-to-day lives of Earth’s citizens and forcing governments across the globe to take unprecedented measures to contain its spread. In the U.S., non-essential businesses were ordered closed in many states, and at the time that this article was written (September 2020), a good deal of businesses remained closed or only partially open.
Small to mid-size businesses have been particularly affected, with many lacking the resources needed to outlast the prolonged shutdown, and others scraping by in the face of poor economic conditions, historic unemployment and a highly uncertain future. In general, the combination of these factors has placed downward pressure on the value of closely-held businesses, and caused wrinkles in the appraisal process that have given valuation professionals headaches.
Among the more notable questions that business appraisers must now consider include:
- Valuation date – When did the impact of COVID-19 become “known or knowable”?
- Market approach – What is the relevance of private company transactions and public company multiples that commenced or were derived prior to the current crisis?
- Income approach – What impact does the increase in risk and highly uncertain future have on a company’s growth prospects?
- Asset approach – What impact on value has the crisis had on a company’s underlying assets?
The fair market value and fair value standards compel us to only consider information that is “known or knowable” on the valuation date. There seems to be a general consensus among valuation professionals that the downturn in domestic economic conditions stemming from COVID-19 could have been reasonably foreseen beginning around the end of February 2020 (though it would take a few more weeks for states and the federal government to take any serious measures to contain the spread of the virus). In other words, prior to February 29, 2020, the economic impact of the coronavirus crisis could not have been known or knowable by a hypothetical willing buyer or willing seller of a subject company’s equity. Concerning the seriousness of the pandemic, though, there has been much divergence and deliberation about who knew what and when, with no clear-cut answer.
When valuing a private entity, the market approach may be the most affected by the ongoing pandemic. The market approach values a business based upon multiples paid in recent transactions or observed in the public markets. For valuations after February 2020, market multiples based on pre-crisis transactions may be less meaningful and/or no longer relevant. What’s more, consideration must be given to the relevance of public company multiples derived using pre-crisis financial or operating results.
While historic earnings are normally considered, the primary factor driving business valuation is expected earnings. Thus, most projections prepared before COVID–19 will need to be revisited in order to accurately reflect expectations on the valuation date. On the flip side, for appraisals with valuation dates prior to March 2020, extra precaution must be taken to ensure that the impact of COVID-19 is not reflected in any forecasts relied upon. While never easy, estimating future cash flows has certainly become more challenging, as has the determination of an appropriate discount rate. While the company-specific risk premium will likely be higher than it would have been pre-crisis, the current data used to compute the cost of equity is in many cases only just beginning to reflect some of COVID-19’s impact.
Holding company valuations have also been materially affected, as they generally hinge on the value of their underlying assets. Given the substantial market volatility witnessed in 2020, the value of a securities holding company might vary wildly from day to day. Real estate values, meanwhile, have generally trended downward, with rents often going unpaid and mortgage payments missed. As a result, real estate appraisals undertaken even in the very recent past may no longer be accurate.
Overall, valuations with effective dates after February 2020 have become more challenging to perform, and the premise of going concern has generally become more important. In many cases, substantial valuation discounts may be warranted in order to account for the heightened risk and uncertainty brought on by COVID-19, while the selection of an appropriate valuation date will be more crucial than ever in any estate planning efforts.
Terrel J. (Murph) Lavergne, CPA/ABV, CVA, a Valuation Consultant and Southern Representative for BCG Valuations, is a member of the American Institute of Certified Public Accountants (AICPA), the Florida Institute of Certified Public Accountants (FICPA), and of that group’s Valuation, Forensic Accounting, & Litigation Services section (VFALS). He is also a member of the Palm Beach County Estate Planning Council. Matthew R. McCranor, ASA is a Vice President and Partner with the Company and is Vice President of the Princeton Chapter of the American Society of Appraisers (ASA). BCG is a nationally recognized firm specializing in valuing business interests for purposes, including estate, gift and income taxation; purchase and sale of minority and controlling interests; preferred recapitalizations; litigation involving business and securities valuation issues; and general corporate and shareholder planning. For further information go to www.bcgvaluations.com.