The COVID-19 pandemic has created uncertainty for businesses and volatility in the global economy. The travel bans, lockdowns, social distancing restrictions, supply disruptions, and consumer caution amongst other factors have resulted in significant challenges for many businesses. The Australian Federal and State Governments have introduced a number of stimulus measures, however, the longevity of the financial impact on businesses and the wider economy is still evolving.
All of these COVID-19 related issues have resulted in uncertainty surrounding business valuations, causing challenges for valuers and lawyers needing to advise their clients in litigation proceedings.
So can valuers provide an opinion or approach that enables the Parties to make informed decisions, and if so, how?
The International Valuation Standards Council noted in March 2020 that “the existence of significant uncertainty does not mean a valuation cannot be undertaken…” In practice, the current COVD-19 pandemic has made the business valuation process more complicated but by no means impossible or inaccurate.
“Valuations need to be assessed in the context of the economic fundamentals and financial market conditions prevailing at the valuation date.”
Uncertainty surrounding the COVID-19 pandemic has renewed the importance of the first principles of valuation.
The Discounted Cash Flow (DCF) methodology is the most theoretically sound valuation methodology and the preferred valuation methodology in uncertain times.
This doesn’t preclude the utilisation of other methodologies such as capitalisation of earnings, however, greater care must be taken when selecting the appropriate valuation inputs.
Depending on the exposure of the business to economic or social factors such as further lock-downs it may be appropriate to value the business under a number of different scenarios, such as a forced shutdown scenario.
A probable weighting can be applied to the values derived under different scenarios to determine the value of the business as at the valuation date.
The best practice approach for determining cash flows or earnings of a business has not fundamentally changed as it should reflect the cash flows or earnings that the business expects to make.
However, historical performance may no longer be an indication of future performance.
When using an earnings-based valuation methodology the following could assist with determining earnings and the resulting business value:
- Analysis of Pre-COVID earnings compared to earnings up to the valuation date to obtain a thorough understanding of the impact of the pandemic on the Business. Comparing Pre-COVID earnings against the prior year period would also be relevant to understand how the business was performing Pre-COVID and whether that trend would have been expected to continue.
- Discussion of earnings expectations for the future, whether any expected reductions in profit are temporary or ongoing, and if the reduction should be reflected in the earnings assessment or rather deducted from the derived Business Value if they are considered to be temporary in nature.
- Use of an appropriate COVID-19 multiple or discount rate that reflects the market at the valuation date. It may also be appropriate to include an alpha in the DCF discount rate to reflect the uncertainty of cash flows in businesses which are especially difficult to determine forecast earnings, or where the cash flows themselves have not been risk-adjusted.
- Business typically transacts on a cash-free/debt-free basis and therefore the value of cash on hand is usually included as an asset surplus to the value of the Business. However, if the Business is experiencing working capital difficulties due to COVID-19 it may be appropriate to consider whether part or all of the cash balance is required to meet any working capital deficiency and therefore forms part of the assessed value of the Business.
Valuations obtained prior to the COVID-19 pandemic may no longer represent the current value of a business.
However, the existence of uncertainty surrounding the current pandemic does not impede a valuation from being undertaken but rather a greater level of care and caution must be exercised when selecting the valuation methodology and the appropriate valuation inputs.