The COVID-19 global pandemic can be expected to impact Alberta business values in both the short and long term. Our own David Laycraft suggests that business owners should consider the following as they work to preserve their hard-earned value:
“First and foremost, value is a function of future cash flows that the business is expected to generate. So, business owners should be mindful of three factors:
1. While historic results are often considered to be reflective of the future for mature businesses, this may not be true if COVID-19 has impacted their supply chains, operations or demand for their products and services in a meaningful manner. Most owners I have been speaking with are finding projecting the future – both over the next quarter and for the next few years – to be extremely difficult. And this may be even more challenging for start-ups or young businesses that are still establishing themselves.
2. Free cash flow is a function of many variables, including revenue, margins, expenses, annual capital expenditures, working capital requirements and income tax rates. All of these components have either already been impacted by COVID-19 or are expected to be in due course. And if the business is primarily involved in the resource sector, the recent global oil and gas price collapse is an additional factor that is materially impacting cash flows.
We recommend that owners prepare their cash flow projections:
- For as long as it is expected to take the business to return to “normal” levels – many owners I have been working with are estimating this could take 1 – 4 years; and
- Under several different scenarios – this should allow the owners to understand which of the preceding factors have the most impact on their cash flows and plan accordingly.
3. To your cash flow projections, a multiple, which reflects both the risk in achieving these results and future growth, is applied to arrive at the value of the business. Some issues that valuators such as myself are currently grappling with include:
- Whether historic multiples paid for comparable businesses, paid pre-COVID-19, are appropriate;
- Whether the current low interest environment we are now in is reflective of long-term rates;
- Whether industry capital structures have been permanently changed;
- The extent to which marketability of the business has been impacted; and
- Whether a specific COVID-19 risk factor also needs to be considered
Value is also impacted by a number of non-cash flow related items, including:
- The underlying tangible asset base of your business – particularly working capital and your ability to access external capital – will be crucial for the foreseeable future. These resources will give you the best chance of navigating through any cash crunches you might encounter, using either your own cash or established credit facilities with your bank or suppliers. Generally, companies with higher tangible asset bases are more valuable, as they have more available security and lower perceived risk, than a business with more value tied-up in intangible assets (or goodwill).
- If “fair market value” is being sought for a more formal purpose (such as a corporate reorganization or for dispute purposes), a key valuation principle is that value is determined at a specific point in time, using facts that would have been known by market participants. This means that hindsight evidence can only be used to test the reasonableness of assumptions made at the valuation date. So, the date that the valuation is being prepared at can have a significant impact on value, especially with COVID-19 as a backdrop.
- Value is influenced by liquidity. Think of this this in terms of supply and demand: if COVID-19 chases buyers to the sidelines for a prolonged period, then multiples and values would be expected to fall over time.
The value of a privately held company changes every day – the working capital position changes, new opportunities emerge and market conditions are constantly changing. This was true twenty years ago and will still be true long after the pandemic is a distant memory. But first, all business owners must face the challenge of navigating the extreme turbulence created by COVID-19, and Catalyst is here to assist our clients so that we all emerge on the other side.”
David Laycraft P.Ag., MBA, CMC, CBV, CF, CDFA
David has over twenty years of diversified experience working with privately-held businesses, and regularly assists clients in identifying, measuring, growing and realizing business value.
David can be contacted at (403) 750-7685 or email firstname.lastname@example.org