Impact of COVID - 19 on Business Valuation

24-November-2020 by Virtue Ventures

Numerous organizations have experienced significant declines in market capitalization as a result of the unprecedented impact of COVID-19. Some of these impacts may be tied to temporary factors and extreme volatility in the markets, while others reflect longer enduring or even permanent shifts in the business in which these companies operate.

There is no disagreement that the current worldwide crisis will cause the global economy to go into a recession. In such an uncertain situation, we would have to evaluate how best to value businesses and assets, and valuation can be based on fundamentals (intrinsic valuation: DCF), compare its pricing to how similar assets are priced (relative valuation: market multiples), based on the cost of individual assets in its books (asset based), thereby assisting to determine fair value.

Impact of pandemic on Valuation Methodologies:

Methodologies to determine fair value have not changed; however, management may need to examine which valuation methodologies are most appropriate in the current condition. For example, a discounted cash flow method (DCF) may have benefits compared to other valuation approaches, because this model focuses on the intrinsic value and fundamentals of companies. This discounted cash flow model also has the benefit of being more adaptable compared to other valuation models to capture the assumptions that are relevant in the current economic condition. Especially, a discounted cash flow (DCF) approach can direct both the current shock to demand and supply triggered by social distancing and stay-at-home orders, as well as consideration of recovery and post-recovery assumptions. Certain inputs and projections used in applying the approaches may need to amend or should be given further consideration.

Cost Approach

In case of Property, Plant & Equipment and intangible assets including Goodwill, companies must judge whether the impact of COVID-19 triggers an impairment assessment and, if as a result of that, whether an asset impairment has occurred or not.

In case of Inventory, Companies must check out whether inventory is held at the appropriate carrying value. Any change in carrying value on account of COVID-19 must be appropriately adjusted.

Companies must assess the expected credit losses that will be incurred as a result of the impact of COVID-19 on their customers and recognize credit loss provisions for increment in expected non-recoverability of receivables.

Market Approach

As of March 31, 2020 market multiples have moved significantly over the quarter and significant uncertainty exists with respect to company performance and achieving projections.

A valuer should also take into account the recent transaction multiples may or may not consider the current market environment and therefore may or may not need adjustment depending on the individual facts and circumstances.

Income Approach

Updated projections after considering the impact of COVID-19 with appropriate value drivers should be used by a valuer. The impact on an individual company’s results and outlook may be positive or negative based on the industry of the company.

If updated protections are not available, value drivers may need to be adjusted to account for increased risk and uncertainty due to pandemic.

General Effects on Businesses:

Decrease in business values 

Here are just a few reasons why the value of private assets may have declined due to COVID-19:

  1. Actual and expected revenues and earnings may have decreased due to forced COVID-19-related closures or decreases in client demand.
  2. Interest-bearing debt may have increased to pay employees and other fixed continuing expenses.
  3. For minority interests in privately held companies, discounts for lack of control and lack of marketability may have increased due to liquidity issues in the market.

Projected Cash Flow Modelling

The valuation of an interest in a private company is based on the future economic advantage that an investor might anticipate to receive. The valuer will value the business at the given date dependent on what is foreseeable or reasonably foreseeable at the effective date of the valuation. Typically, in valuing businesses we are assessing future cash flows based on past performance and supported projections. The challenge for valuers at this point in the pandemic is that there is noteworthy uncertainty about the extent to which historic data can be used to guide the valuer in assessing their future expectations about the business. In other words, the recent past may not be a reliable guide to the future.

Increase in business risk

COVID-19 has maximized the threat of doing business due to the doubtfulness of how each business will be affected. Risk is usually reflected in discount rates utilized in Income Approaches to valuation such as the Discounted Future Cash Flows Method. Greater uncertainty results in higher risk, which in turn justifies the demand for greater returns. This will ultimately result in lower asset values.

Impact on Merger & Acquisition

In spite of the fact that it's too soon to determine what influence of COVID-19 will have on the possible M&A transaction, many buyers and sellers are simply taking a wait and see approach. Adjustment to financial performance for COVID-19 will unquestionably become part of the discussions in every deal and those adjustments will influence deal values. Sellers are well advised to provide buyers with financial forecasts, reflecting the going to impact of COVID-19, including what a postCOVID-19 condition is most likely to look like.

Under this unprecedented time, to cut back the impact of uncertainty, it would be prudent to figure on a different set of prediction, perform scenario analysis and also document properly before closing worth. The valuation for financial reporting in 2020 would stay testing and valuers would be required to apply all valuation approaches before concluding value. Clearly, it can be said that Business Valuation is on the far side the numbers and the valuer’s experience and knowledge would matter the foremost in these testing times for valuing companies for various of purposes including Financial reporting.