How Does COVID-19 Impact Business Valuation?Deal Structuring & Mergers & AcquisitionsBy Profit Board
COVID 19 does not require any introduction. So, let’s dive straight into our discussion for the day – How does COVID 19 impact business valuation? As COVID-19 has permeated every aspect of our lives, it is no surprise that the economic impacts of the pandemic will affect business valuations, too.
In the coming time, the major issues for valuers to consider would be:
- The use of subsequent events
- The choice of valuation methods
- Business cash usage rate
- Increased Auditor Scrutiny
(A) The use of Subsequent Events
There are two main sub factors that will drive this considerations – the date of valuation and the purpose for which the valuation is being done.
Now, technically, business valuations do not account for events occurring after the valuation date. They only account for for what was “known or knowable” as on the valuation date.
In order to determine whether the impact of COVID -19 was known or knowable as of the valuation date, a valuation expert needs to understand the timeline of COVID-19 in their respective countries.
For eg: in the US, most experts believe that as of December 31, 2019, COVID-19’s impact was not known or knowable. However, for valuation dates through the first part of 2020, experts will have to make an assessment based on the specific valuation date, the information that was known and available as of that date, and to what extent it should be taken into account in the valuation.
Also,experts would need to consider the purpose for which the valuation is being done. For example, legal bodies may prefer to see real-world events (such as COVID-19) incorporated into valuations, and the standards allow disclosure of significant subsequent events.Therefore, a valuation expert may include additional analysis and language explaining the impact of the subsequent event (COVID-19) on the performance and value of the subject company.
(B) The choice of valuation methods
There are various methods for drawing up a business valuation. However, the economic circumstances created by COVID-19 make some methods potentially more appropriate than others.
For example, under Discounted Cash Flows (“DCF method”), the expert projects the businesses future financial performance over a certain period of time (generally five years). Under Capitalization of Cash Flows (“CCF”), the expert picks a single income stream, based on historical results, to project future income. Now, owing to economic disruption caused by COVID 19,DCF may turn out to be a more apt method. This is owing to the point that it allows the expert the liberty to address each of the years individually. This method will still be challenging as a period of relatively increased uncertainty continues, and experts may consider using multiple scenarios to model the business’s performance over the next 18 to 24 months.
(C) Business cash usage rate
Cash flow has always been one of the crucial factors when it comes to valuations. An expert will now consider the business’s cash balance and cash burnout rate in assessing the business’s ability to continue operations. The consideration of the company’s longer-term prospects is also an important consideration when assessing the risks facing the company while determining a company’s discount rate.
(D) Increased Auditor Scrutiny
Valuers can expect greater scrutiny from auditors this year, stemming from the unprecedented market changes, which have created impairment triggers, and so increased the impairment risks.
The key to counter this is to document their assumptions, working papers, management reports, and most importantly, recording of assumptions. Some steps that can be taken to safeguard against auditor scrutiny –
- Ensuring evidence for compliance meets valuation standards
- Setting out clear cross-checks that substantiate opinions
- Providing enough detail for the valuation to be performed easily again
- Ensuring the report is fit-for-purpose and the scope is not unrealistically extended
As the economy and consumer behavior changes, there were will be companies who can capitalize on this moment in time and do better than was originally anticipated.
Experts are doing their best to consider the unpredictability of the current environment. When reviewing valuations prepared during this period, the user should assess how the expert addressed these issues in their analysis.
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