Business valuation has never been more interesting than in 2020 and 2021. The ups and downs created by COVID-19 and the varying responses by politicians and the business community have created quite a roller-coaster. I find many of my clients, bankers, business owners and their advisors asking:
“So, where are we now?”
The current belief appears to be that the worst of the virus is behind us and we are moving into a post-COVID future in business and business valuation. It appears that the high-risk period caused by the coronavirus is behind us. If this is the case, when all things are equal, there will be little to no downward assessments when thinking about the reactions to future effects from COVID-19. Let’s hope for many reasons this optimism turns out to be warranted.
While each business and every business valuation is different (after all, that is why we do the work), I can break the current environment down into three classes.
Group One – Nothing Happened
Of course something happened: shut downs, employee safety or work from home issues, supply chain issues, new signage everywhere, and screens were just a few of the most visible things. But in the “Nothing Happened” group, the underlying company continued to deliver value to customers and clients. Any interruptions were brief and the business either made up the lost revenues or resumed right where it was on a monthly basis as soon as it was allowed to reopen or customers were allowed to leave their homes.
Companies in this category are many service providers like accounting firms, service repair companies, and basic essential businesses like grocery stores. These companies and businesses are being valued as they always were. In fact, many may have a higher value for having shown resilience in difficult times.
Group Two – It Got Really Good
Many industries and companies benefited greatly from the pandemic. For example, indoor signage companies, outdoor recreation, and clothing manufactures that produced masks quickly and liquor stores that supplied alcohol at higher rates than pre-pandemic, not to mention Zoom and tech companies of all stripes that made working from home and connecting with loved ones easier. Some of these businesses may stay strong in the “new norma,l” but many are likely to show 2021 as a bubble with exceptional results.
Valuation is always forward looking. After all, you would not make a personal investment that had paid 20% returns last year if you were told it was not going to pay anything in the future. That is the nature of value. Therefore, the issue in valuing these companies is estimating a likely future cash flow. In many cases, a review of past data can be a good indicator for a likely future cash flow. But, what about the company that doubled revenues and had 5 times the earnings of prior years? Determining a likely future cash flow for that company requires judgment. Otherwise, like the companies in the first group, the overall risk is likely to be viewed as being reduced. The likely future cash flow will (at worst) remain where it was pre-pandemic, and possibly increased post pandemic. These companies as a whole have increased in value.
Group Three – What The Hell Just Happened?
One of my favorite quotes is by the boxer Mike Tyson, “Everyone has a plan until they get punched in the face.” Group three is made up of companies that got punched in the face, and in many cases knocked out.
The results of companies that fall in this category can vary greatly depending on their location and specifics. For instance, a formal high-end sit-down restaurant in New York City would have been much more impacted than a mid-priced restaurant in an outdoor resort town that could do outdoor seating and take-out. But, all of these companies have reduced profitability to large losses. Many may never reopen. Many of the businesses in group three are in entertainment, tourism, and restaurant sectors.
Some of these companies are quite easy to value. As of a current valuation date, they have nominal or no value. Namely they may have value in the future, but they do not today.
However, others in this group are the most difficult to value as they have limped along and now have strong prospects for a banner year followed by a hoped for return to the “old normal.” Common sense says this is likely to be true but valuators are required to have a reasonable basis for their opinion.
Reasonable basis can come from many places. One of the easiest to work with is the monthly income statements that show returning revenues. Another source is well-prepared and supported projections that tie into economic and scientific data, which show a decline of the effects of the virus and a return of the economy. Again, the required evidence of a “return” is going to vary with the business and how hard the business was “knocked-out.” Yet, these companies now have a risk that they have not fully escaped. Therefore, most of these businesses will have a reduction in value from pre-pandemic for a while at least until projections hopefully become a profitable reality.
The United States and business in our country appears to be quickly returning to normal. Hopefully the vestiges of COVID-19 will quickly be left behind. But, business profitability, risk, and ultimately business valuation remains much more nuanced in a post-COVID world.
I’ve written more about COVID-19 and business valuation for BVC, the Business Valuation Resources publication, and NACVA QuickRead:
No matter what the financing event you are facing is– buying a business, selling a business, getting a loan, or acquiring a partner– you will need a valuation. Understanding how the value of a business is determined is also important because then you can feel confident in knowing what your business or the business you want to buy is really worth. And even if you aren’t ready to sell or apply for a loan yet, knowing how much your business is worth can help you plan for the future.
NerdWallet, a company that explains financial information to consumers, recently published an article that outlines the major things you need to know about small business valuation. Read the full article at this link.
They explain the terms and acronyms you’ll need to know, like SDE and EBITDA and how to organize your finances and determine your assets. They also suggest you do what we always do: find out more about your industry and what businesses of similar size, revenue, and business model are worth. They also outline three approaches for valuation, but if you want more information about these methods, you can read my recent blog post.
As they write, “No matter where you are in your business’s lifecycle, learning how to determine a business’s value is a great way to better understand your own business’s finances and assets within the context of your industry.” We always stress that Business Valuation is both a science and an art. To find out more about professional valuation services for your business, contact me to learn more.
When we determine the value of a business because someone wants to buy, sell, finance, or for other purposes, the Standard of Value used impacts every element and the ultimate value found.
Standard of Value simply defines the agreed-upon transaction terms that form the basis for an exchange and estimating a business value. If you have ever bought or sold something, you already know the basics of what we call a Standard of Value. For example, if something is being liquidated quickly, you might have different expectations of price and terms than a market sale with no time pressure on either side. In addition, each participant in the process may see and value things differently. Using a home as an analogy, a seller may love that the home has a pool, while a prospective buyer may see that as a liability. In the end, however, the ultimate buyer and seller have to agree on what they are willing to pay for the house or there is no sale.
Standard of value, in essence, is a shorthand for the deal terms if the business valuation was a real transaction.
Like a home, each business has different attributes and assets and liabilities. Unlike a home, businesses have varying levels of complexity to run and different profitabilities. In the end, who the buyer is and who the seller is (and what they value) along with the pre-established terms of the transaction is specified by the standard of value selected for the business valuation.
Sometimes the standard of value is selected by the valuator to be the one most useful to the users, for instance using fair market value for planning a sale. Sometimes the standard of value is specified such as in many legal disputes fair value is called out in many statutes. Here are 7 common standards of value.
Fair Market Value
In a theoretical world, fair market value is as simple as what a hypothetical buyer is willing to buy for and what a hypothetical seller is willing to sell for. In reality, these are a fictitious buyer and seller not the actual ones in the transaction. When actually valuing a business, you have to take into account who makes up the pool of buyers and how they would look at it. The seller is a typical seller who is prepared to sell. Both parties are assumed to have reasonable knowledge and a willingness to transact fairly quickly. One other element of this standard of value is the transaction is paid for in cash at closing. This is probably the most commonly used standard of value.
Market Value
Market Value is much closer to a real-world scenario as it includes a reasonable marketing period prior to the transaction. This is an international standard and not frequently used in the United States. Once each party actually has knowledge of the transaction, it is the, “best price reasonably obtainable by the seller and the most advantageous price reasonably obtainable by the buyer,” according to IFRS, the international standards for Accounting Standards.
Fair Value
Fair value has multiple definitions between common use in state courts for divorce and business disputes and for use in GAAP for financial reporting. We will work with the definition used by many states for disputes.
Fair value comes into play when valuing a minority or lack of control ownership interest in a business. Because minority interest owners tend to be “along for the ride” instead of in control their interests have less value under a fair market value standard (i.e. how much would you pay for 20% of a company where the person that owns 80% says they will not pay you or distribute money to you–ever, and they legally can do that?). Under fair value the minority interest is specified to be a pro-rata share of the total value of the company. So, in our scenario above, if the company was worth $1,000,000 the 20% interest would be worth $200,000. That is fair value.
Investment Value
The opposite of fair market value is investment value. In this scenario, both parties are known and the value is determined to the specific participants. In some cases this might result in a fair market value and in others a synergistic value.
Intrinsic Value
Intrinsic value can have two different meanings, one used for divorce litigation and asset valuation and one used for business investment valuation. In Virginia divorce law, for example, intrinsic value is the subjective value that a party places on a property or asset. That subject value then needs a monetary value, which can be very complicated to determine. For investors, intrinsic value is almost the opposite of that. It is an analytical judgement of the underlying value, regardless of who the investors are (similar to fair market value). Usually this is more of a discussion point and it is rarely used as a standard of value even by investors in formal business valuations.
Synergistic Value
Sometimes, a business in itself can have multiple assets, and those assets combined are worth more together than as separate entities. Namely, the company being purchased will make more money for the buyer than the company can on its own. This is called synergistic value. This could include a biotech company who has intellectual property on a vaccine and a factory to produce that vaccine. Together, the two could be much more valuable than each separate part.
Liquidation Value
The value determined when you sell each asset of a business is called the liquidation value. This is almost the opposite of synergistic value, since each piece of the business may be worth less than the business as a whole. In an orderly liquidation, assets are sold over time so that they can get the best value. In a forced liquidation, sellers have to take a quick and usually financially worse best-offer approach in a limited time frame like an auction.
These are very brief explanations of 7 common standards of value, but all of them relate to the question: Who is the buyer and who is the seller and how much time do we have to sell? The professional judgement of a valuator helps determine a standard of value that matches the real-life transaction that is happening.
April 24, 2021 at from 11:45 AM to 1:15 PM is the next New Jersey Exit Planning Exchange meeting.
Gregory Caruso will be presenting to the New Jersey XPX Association on “Small Business Valuation in a Post Covid World”
The presentation will focus on how Covid has affected small business and business valuation in different industries and locations. Data from a variety of sources will be used to show the different effects on large companies, middle market companies, and small companies. Marketability discounts and iterative projections will be presented as ways to deal with high risk situations.
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” covers many professional judgement scenarios, explains calculations and standards in great detail and addresses other important valuation issues. You will also have web access to download sample reports, calculators and checklists. You will reach for this complete resource time and again.
“This is a book review of The Art of Business Valuation: Accurately Valuing a Small Business by Gregory R. Caruso, author. This book is a guide and desk reference published by Wiley for valuing small and micro businesses under $10 million in revenues.
The primary question answered in the book is: How do we as business valuators, business brokers, accountants, lawyers, owners, and other interested parties who prepare, review, evaluate, or use business valuations for small and very small businesses in difficult environments?
This is an environment where owners are still engaged in planning for the future. The owners are taking out loans. They are adding and eliminating partners who are often lifelong friends or family members, adding to the volatility of the mix. They are getting divorces. Some are even selling or filing for bankruptcy.
All of these common activities require an accurate business valuation; this is not just a matter of applying techniques, it requires that the person valuing the business continually ask him or herself “Does this make sense?”
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” has 400 pages covering many professional judgement, calculation, standards, and other important valuation issues along with access to sample reports, calculators, and checklists downloadable from the web. This will be the one book you will reach for if you value or rely on valuations of micro or small businesses with revenues under $10 million. The book published by Wiley is available at your preferred bookseller. To Buy from Amazon Click Here
Greg Caruso, JD, CPA, CVA, the author of “The Art of Business Valuation, Accurately Valuing a Small Business” 2020 published by Wiley is always available to prepare (or review) business valuations for all purposes and situations.
JOIN our email list to stay current on changes in small business valuation. Things like how addressing Covid is changing business valuations.
A forecast provided by management was analyzed to evaluate the usefulness and veracity for use as a base line cash flow in the business valuation. The projection showed rapid growth but unfortunately, as is common in small and micro business valuation, the forecast was not terribly useful and was not likely to be accurate enough to use in a discounted cash flow model as the income stream was too speculative. For that reason reducing the cash flow to closer to the historic average cash flow was a necessary adjustment made in valuing the company.
The Company also had a weak balance sheet. Strong balance sheets provide stability during economic downturns as general contractors can be highly cyclical. This weak balance sheet was a reason to reduce the multiplier or increase the capitalization rate reducing business value due to high risk of the projected cash flow not being met even after adjustment.
Other concerns and adjustments were reviewed in the article. The complete article is available here.
This article is the first to be published in a new column appearing every other issue called, “Size Matters, Valuation of Small and Micro Businesses”. I am honored to be asked to write this column for The Value Examiner.
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” has 400 pages covering many professional judgement, calculation, standards, and other important valuation issues along with access to sample reports, calculators, and checklists downloadable from the web. This will be the one book you will reach for if you value or rely on valuations of micro or small businesses with revenues under $10 million. The book published by Wiley is available at your preferred bookseller. To Buy from Amazon Click Here
Finally Greg Caruso, JD, CPA, CVA, the author of “The Art of Business Valuation, Accurately Valuing a Small Business” 2020 published by Wiley is always available to prepare (or review) business valuations for all purposes and situations.
JOIN our email list to stay current on changes in small business valuation. Things like how addressing Covid is changing business valuations.
