SB Partners Valuations Division participated in a Virtual Town Hall focused around the impact of COVID-19 on business valuations. The talk was organized in collaboration with several global valuations governing bodies including the Canadian Institute of Chartered Business Valuators, American Society of Appraisers, and The Royal Institution of Chartered Surveyors.
A panel of valuators and appraisal experts offered practical advice on the impact of the pandemic on valuations and those whose charge is to complete them.
Listed below are five key highlights:
1. Valuation conclusions will be lower in comparison to the periods prior to COVID-19, all else equal.
While being a rather obvious expectation, the Pandemic is causing declines in value as profits are diminished and overall risk has increased. From a quantification perspective, one of the esteemed panelists for the town hall indicated that he was expecting on average a decline in the total value (enterprise value) in order of magnitude of between 10% to 15%.
2. A change in valuation modeling
Valuators will be hard-pressed to capture the volatility of earnings and cash flow generation as well as the risk and uncertainty in their cash flows using “normal” valuation models. Of all the tools in a valuators tool kit, the Discounted Cash Flow Model and variants will likely be the preferred and most generally accepted means of deriving an appropriate valuation conclusion. This is because the methodology enables valuators to capture both the declines and ultimate improvement in earnings over time adjusted for risk capturing the swing in a company’s business cycle as caused by the Pandemic.
3. Valuation dates – (Pre and Post Pandemic)
A fundamental valuation principle is that “Value is determined at a specific point in time. It is a function of facts known or knowable, and forecasts made at that particular point in time”.
In completing a valuation, the date selected will be important, as with any valuation the valuator is required to use all known facts and information knowable at this date, however, given the speed of progression of COVID-19, there could be vast differences in value conclusions over a short period for any company. A valuation completed on December 31, 2019, would likely be significantly higher than a valuation completed on March 31, 2020, just three months later. Under any circumstance, both internal and external changes that impact the prospects of a business will likely lead to a change in value.
In the context of valuations for family law, equalizing on values that were determined well in advance of the onset of the Pandemic (i.e. Prior to March 2020) will prove challenging for the business-owning spouses, as the intrinsic values determined will likely be significantly higher than the amounts the owner could actualize realize on in a transaction following the start of the Pandemic (declared globally by the WHO March 11, 2020).
4. Cognizant of management and client biases
Now more than ever, client biases from minimal valuations for family law purposes in order to reduce amounts paid to ex-spouses for equalizing family assets; to management taking ‘baths’ on asset (i.e. goodwill and intangible assets) impairments, will require valuators to maintain a healthy level of professional skepticism when vetting assumptions regarding the outlook of subject companies, and the volatility of expected cash flows in relation to the impact of COVID-19.
Value is prospective as it is the present value of all future benefits anticipated to accumulate by virtue of ownership of a business. With so much uncertainty and volatility during this current environment, it will be difficult for valuators to conclude on intrinsic valuations of companies, as management’s outlook will need to be checked to industry and economic outlooks, wherever possible.
5. Merger and Acquisition Activity, Private Equity and Dry Powder
It was also communicated that there is some optimism for M&A transaction values and volumes despite the negative impact of COVID-19 and investors’ current palettes for risk. However, private equity firms are expected to take advantage of depressed values caused by the Pandemic considering the continued large amount of available dry powder, mitigating the impact of the decline in intrinsic valuations due to COVID-19.
As Canada is faced with significant unemployment rates, worsening as the virus decimates the economy, a significant Federal deficit that is exploding, future tax increases are a given. The economic damage occurring daily is also significant. However, recovery is also a given, what goes down must come up, it is only a question of timing – the same will hold true with business valuations.