We are continually asked to value businesses, something that you will find any advisor saying is always an art rather than a science. With that in mind though in current circumstances, we are being asked: how do we factor in the impact of COVID-19?
It would be glib to say that there is no real impact as a valuation should always be based on the net present value of future cash flows as, as is the case for many of our clients, they do not have a financial model of the next five or so years of future cash flows. Instead, we are more often looking at the recent past financial results as the proxy to establishing maintainable earnings and applying a profit multiple.
This leads to the next question, what is maintainable earnings?
The majority of businesses have fared very differently due to COVID than they would have done in the normal course of business.
- Once they adjusted to social distancing requirements, supermarkets have seen demand increase and huge growth in online shopping.
- Zoom saw demand sky-rocket.
- Kooth, a business focused on children’s mental health, has seen demand increase, unfortunately.
Other businesses were shut in the first lockdown, but reopened in June 2020, having furloughed large numbers of staff. And then most of the leisure and non-essential retail has been largely closed or operating at a fraction of previous levels since March. Furlough income has paid for unproductive wages. In fact, we are already experiencing scenarios where businesses have made more profits because of furloughing temporarily, and many businesses have seen their overheads reduce dramatically. Therefore, calculating maintainable earnings means examining the business’s future trading plans and adjusting historical results to fit.
- It means assessing whether previous sales and staffing levels are likely to recover, and if so, how quickly.
- It means stripping out furlough income, non-productive staff and missed sales months. For many, missed sales in 2020 are gone forever whereas for others, e.g., construction, the sales are just deferred.
Have Multiples been impacted?
There is some evidence that multiples have reduced by about 25%. However, it’s important to remember that this is only measurable on completed transactions. Indeed, that would primarily have been transactions completing in the first 6 months of the initial lockdown due to the lag in reporting accurate deal data. Of those early deals, many sellers will have succumbed to selling out at a last-minute discount, rather than risking deferring the deal indefinitely. Therefore, it is no surprise that the data would show such discounts.
The alternative is true when we look at the stock markets, which rebounded quickly from the huge initial impact in March 2020. Therefore, rather than focussing on comparable historical transactions, we must again take a more common-sense view based on long term trends.
Debt and working capital
Most transactions and therefore, most valuations are also impacted by a net debt/net cash calculation and consider the necessary working capital position. Whilst it is easy to say that debt is easy to calculate, this misses part of the point. We will see a shift for some businesses in the sustainability of debt, as we suspect the average business’s debt capacity will not be as great in 2021 as it was in 2019. For working capital, the impact of deferred VAT payments (which I would transfer to debt rather than consider in working capital), rent payments, and the impact of changes to supplier payment terms (as well as non-COVID issues such as changes due to Brexit) all mean it is not as simple as just taking the average actual working capital of the last twelve months as the basis on calculating the next twelve months average requirements!
So, valuing trading businesses in the COVID impacted world has certainly made valuers think back to fundamentals and makes the job that much more interesting, but not impossible.
This article was written by Simon Blake, For any questions regarding this article, you can contact Simon on the form below.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.