By Dan Rosio
As the country focuses its attention on COVID-19, and with only essential businesses operating in much of the country, many private companies in a variety of industries are suffering the economic impact of the current public health crisis.
Although it may be difficult to determine the short- and long-term impact on valuation of a private business, one fact will not change – company value will still be determined using these three commonly accepted valuation approaches:
• Income approaches rely on earnings or cash flow generated by a company.
• Market approaches rely on public stock market data and transaction data.
• Asset approaches rely on values of the underlying assets of the company.
With the recent decline in the public stock market, caused in part by the global effects of the pandemic, the market approach would be most affected when used to value a private company. However, with many businesses concerned about current and future earnings, the income approach will also be largely affected.
The current dilemma
Standards in the business valuation industry compel the appraiser to consider the facts “known or knowable” as of the valuation date. If presented with a situation to value a company today – with what is currently known versus what was known at a date prior to the pandemic (such as Dec. 31, 2019) – it seems obvious that today’s value would be negatively affected from what it might have been on Dec. 31, 2019. The current “known or knowable” facts are based on the knowledge of a public health crisis and the decline in the public stock market.
Additionally, other valuation approaches, such as the income approach, would likely be affected as many businesses are suffering significant reductions in income and cash flow. Because application of the income approach is based on historical or future projected cash flow, many businesses may find it extremely difficult to provide an appraiser with meaningful projected revenue, expenses and cash flow expectations. With the inability of business owners to reasonably project their future performance, appraisers may rely on historical income approaches adjusted for increased risk due to the extreme uncertainty of the future and no reliable date as to when the health crisis might end.
Unique valuation situations
Across the valuation niches, there are certain unique situations to be aware of when making valuation decisions or advising clients on matters that involve valuation issues. Some of these include estate and gift planning, transactions, marital dissolution, and employee stock ownership plan (ESOP) annual valuations.
Estate and gift planning: Many individuals originally planning to make transfers of business interests may feel a shock to their business and other asset portfolios. As the stock market has reacted to COVID-19, individuals should work with legal counsel and other advisors to continue planning and take advantage of the reduced value of assets to make transfers. While no one can predict where the bottom of the stock market might hit, the market is down significantly from its all-time high earlier this year. If transfers were already intended using the values prior to COVID-19, it would seem logical to continue with those transfers as planned – with the added benefit of doing so at the current reduced values. Additionally, to take advantage of the currently low values, there is flexibility in selecting a valuation date for gift tax purposes.
Transactions: This can be a complex area. Certain transactions in private businesses may have been approved, planned, or required prior to the knowledge of COVID-19. In situations when an independent appraisal is required to determine value for the transaction, even if the transaction was not consummated prior to the knowledge of the crisis, it would seem logical and fair to value those interests at a date prior to the knowledge of the public health crisis. This situation has already played out in the healthcare industry, with surgery center/physician transactions that were approved by their Boards of Directors well before year-end 2019.
For transactions that were still in discussions and not agreed-upon prior to the knowledge of COVID-19, a valuation date that considers the health crisis might make the most sense. The primary concern with these specific transactions is trying to determine the valuation date at which the transactions should occur. If possible, it might be advisable to wait until a later 2020 date when the impact of COVID-19 may be more quantifiable. This will obviously depend on an individual company’s facts and circumstances.
Divorce: Marital dissolutions typically value the marital balance sheet at the “date of filing” of the dissolution. Thus, dissolutions involving a private business interest are typically based on a valuation effective as of the filing date. However, as these cases tend to go on for several months and the business performance changes over that time, there is sometimes disagreement over the most reasonable valuation date to use. For cases ongoing during COVID-19 it might be advisable to conduct a second analysis separate from the filing date. Since the division of marital assets has not occurred, and with a potentially significant impact to what is typically one of the larger assets in the dissolution, a second analysis to compare to the original filing date analysis could be helpful to both parties.
Employee stock ownership plans: Regulatory compliance requires employee-owned companies to have an annual update to their stock valuation. Many ESOP companies have a Dec. 31 year-end date. Many of these valuation updates were well underway prior to the COVID-19 health crisis while others were just starting. There are many decisions for ESOP companies to consider for year-end valuation and potential payouts during 2020. A thorough analysis on how the pandemic may affect the annual ESOP valuation process can be found on our blog at https://ksmcpa.com/blog/how-covid-19-may-impact-esop-valuations. While many other unique valuation situations may arise during this turbulent time, the importance of the valuation date and whether it is prior to or after the “known or knowable” impact date of the pandemic is critically important in the appraiser’s value determination. Overall company goals, flexibility or lack of flexibility may determine the best course of action for potential transactions in 2020. For those wanting to take advantage of the uncertainty, it may be advantageous to move forward with gift and estate planning matters.•
• Dan Rosio is the partner-in-charge of Katz, Sapper & Miller’s Valuation Services Group. Opinions expressed are those of the author.