In addition to regular SBA 7a loans and SBA funding, businesses have been able to ask for additional funding through programs like the Paycheck Protection Program (PPP), the Restaurant Revitalization Fund, and Shuttered Venues Grant. Applications for the PPP closed on May 31 and slow rollouts of the SVG, The Wall Street Journal recently asked, “What is it small businesses actually want from the SBA?” And spoke to advocates, business owners, and the SBA about what the post-pandemic assistance will look like.
Below are the major points answering what entrepreneurs want from the SBA, or you can read The Wall Street Journal’s full article here.
Protect and Rebuild Businesses
Scott Gerber, CEO of the Community Company, told the WSJ, “Strategies might include expanding the agency’s outreach efforts to smaller, newer businesses, as well as giving more support to businesses in minority, rural and disenfranchised communities.” In response, the SBA says they are “designing pandemic-relief programs focused on businesses that are most in need.”
Provide Access to Capital
Traditional SBA loans look at credit scores, and if businesses failed to pay rent or other loans during the pandemic because they didn’t have the revenue, their credit scores have been negatively impacted and they might not be able to get loans. Small business advocates say that the SBA should relax rules for the loans, make sure the information on how to get loans is clear, and help businesses understand what they are eligible for.
Be More Inclusive
We all heard the stories at the beginning of the pandemic about who was and wasn’t getting PPP loans. Similarly, advocates are now pointing out that the SBA should “connect with small businesses that have historically been left behind.”
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:
After a recent seminar “Valuing Small Businesses in the Shadow of COVID-19”, I took time at the end to answer some questions from the attendees. Here are some of the questions (and answers!) on using the Income Method to value small businesses that I felt might be most helpful for other seminar attendees as well as business valuators, CPAs, lawyers, and consultants that work with business valuations.
Do you believe projections and forecasts for the discounted cash flow income method of business valuation use will be less reliable during the Covid-19 Pandemic than before?
It is very difficult to estimate reliability of projections for business valuation outside of comparing a company’s prior projections with actual results. Most small companies do not have that type of data or the projections prove to be unreliable pretty much all the time. Therefore I do not believe most projections are less reliable due to COVID-19. There are reasons to believe they may be more reliable. I suspect in most cases much more thought and support will be provided in creating the projections and final forecast. For many companies, instead of being a “add 5% to last year” situation (we have all done it) much more strategy and foresight will go into the whole planning and projection process.
In all events all projections and forecasts for use in an income method of business valuation need to be reviewed carefully from the point of view of, “is this the absolute best that can be done” with what is known and knowable. In the “The Art of Business Valuation”, much time is spent on reviewing projections as it is always a difficult area with a high level of professional judgment.
Aswath Damodaran models deal with changing growth rates and discount rates in the future in order to estimate business value using the discounted cash flow income method. See his discussion of the three state dividend discount model and the H model. Do you agree?
Damodaran is clearly a sage in the field of business valuation. He deals almost exclusively with public and extremely large private companies that may go public. That is entirely different from valuing small and micro businesses typically with revenues under $10 million. Certainly if you are working with a company that can provide a quality projection as a base for use in a discounted cash flow analysis, adjusting the cash flows and the discount rates over time is a reasonable way to estimate the value. In fact, if the data is highly supportable, the discounted cash flow method is theoretically the best method. Of course this is fact and situation dependent like all business valuations.
Many Companies and most small companies cannot give you a reasonable starting point projection or forecast. From my point of view, if I do not have a reliable projection to start from, it is usually best to use a single period valuation method such as the capitalization of earnings method with proper adjustments. Therefore in the proper situations, I agree with Damodaran. But for most micro and small business valuations we will not have the starting point data available to us to use the discounted cash flow income method of business valuation.
On last comment. I will frequently run estimated discounted cash flow models with various potential earnings streams to get an understanding of a companies range of values under possible scenarios. But to me, these are sanity checks and/or information underlying my professional judgement not final valuation methods. A useful tool but if I can’t really support the cash flow, it is not a final valuation method.
Have you ever had a situation where the Company Specific Premium in the Income Method of Business Valuation is negative because risk is lower than normal?
Absolutely but it is quite rare. Every now and then we find a company that is so locked in with its customers (often referred to as “sticky” ; for example, credit card processors can be sticky because they are written into your website) and so well organized and profitable that the risk is below the average public company. But, that is very rare. If you find that company, make sure you really build a well thought out case for your adjustment because it is likely to be doubted. Clearly explain why your company is different and why it should stay that way in the foreseeable future.
More webinars on the “Valuing Small Businesses in the Shadow of COVID-19″ topic and other business valuation topics are being scheduled in the upcoming weeks. If you are interested in participating, please visit our Upcoming Events page
“The Art of Business Valuation, Accurately Valuing a Small Business” covers many aspects of small business valuation and market sales including working with business brokers, increasing sales value, descriptions of a well-run sales process, due diligence including a checklist and guidance on SBA loans.
If you value or use valuations of businesses with revenues under $10 million, you need this book on your desk. The book, published by Wiley, is available through your favorite bookseller.
Finally the author, Greg Caruso, JD, CPA, CVA, is always available to assist with exit planning, brokerage, and to prepare or review business valuations with an emphasis on increasing value and likely transaction values and terms.
This month’s Business Valuation Update published by Business Valuation Resources (BVR) featured my article about implementing a “COVID-19 Marketability Discount”. This is a Discount for Lack of Marketability (DLOM) that arises due to an unusual amount of risk because of COVID-19 and the related economic fallout affecting small and micro businesses.
The methodology used to determine a COVID-19 Marketability Discount can be applied as a separate discount or it can be used as a basis to adjust the historic information based market method multiplier or income method company specific risk premium (SCRP). In many current situations, due to the risk presented by COVID-19, our historic data sources (market method data bases and income method build-up data (BUM method)) do not adequately address the short term risk that is currently being placed on small businesses and their valuations
Micro and very small businesses generally cannot provide forecasts. Therefore the valuation analyst has to use a single period valuation method. As is always the case, the cash flow should be adjusted to reflect the most likely future. But, if the analyst believes an economic recession or 2nd waive of the virus could further impact cash flows there is likely to be more risk to these future cash flows than that reflected in the historic data. Assessing that risk and making an appropriate adjustment is the purpose of this COVID-19 Marketability Discount.
Alternative method: In a new article, an analyst reports that he has been using a “COVID-19 marketability discount” on control interests to make the extra risk adjustment.
“In many situations, I favor the methodology of showing a separate COVID-19 marketability discount,” says Greg Caruso (Harvest Business Advisors), “because it clearly shows the valuator’s thought process and the actual discount being applied for the current high level of uncertainty.”
His methodology is based on the weighing of factors such as those used in Mandelbaum and the IRS DLOM Job Aid but with categories modified to fit the current situation.
Caruso first developed this technique to use in a valuation for an SBA loan. The company was temporarily shut down and appeared to be fully recovered on a monthly cash-flow basis for the two months after reopening. Yet, there was still risk of another shutdown and customers would have economic issues if a recession hit, so Caruso’s basic capitalization rate was a buildup for “normal times,” which included a normal company-specific risk that he further discounted by the COVID-19 marketability discount.
Caruso explains his methodology and presents a case study in more detail with a sample analysis in the November 2020 issue of Business Valuation Update.”
I am grateful to BVR for their support through the years. They are truly a valuable resource.
In the upcoming weeks, I will be conducting several webinars on this topic. Please visit the Events Page for more details.
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” has over 400 pages covering many aspects of small business valuation and market sales including working with business brokers, increasing sales value, descriptions of a well-run sales process, due diligence including a checklist and guidance on SBA loans.
If you value or use valuations of businesses with revenues under $10 million, you need this book on your desk. The book published by Wiley is available through your favorite bookseller or directly from Wiley.
Finally the author, Greg Caruso, JD, CPA, CVA, is always available to assist with exit planning, brokerage, and to prepare or review business valuations with an emphasis on increasing value and likely transaction values and terms.
