Valuations Through the Pandemic

During March 2020, when the COVID-19 pandemic reached the U.S., it not only impacted the health of many Americans but also quickly resulted in economic instability: thousands of businesses were shuttered, the unemployment rate spiked, there was a significant drop in personal consumption expenditures and GDP plummeted. However, the U.S. government intervened, helping to stem further declines by offering unemployment and stimulus payments to eligible individuals as well as programs such as the Paycheck Protection Program to assist businesses in continuing their operations. As a result, the U.S. economy began to recover; still, it has lost ground since early 2020.

Therefore, many business owners, including those at companies with employee stock ownership plans, are unclear as to how COVID-19 will be reflected in the calculation of both the current and future value of the business.

In part, the impact of the pandemic on the firm’s valuation depends on the industry in which the company operates. For example, some businesses were essentially “pandemic-proof” – they continued to perform well even as the number of COVID-19 cases was on the rise. Examples include e-commerce and delivery firms, cable and internet providers, grocery and liquor stores, consumer goods companies and personal IT equipment suppliers. Meanwhile, other businesses were modestly impacted by the pandemic – they experienced a slowdown but made their way through the pandemic. This includes “essential” businesses such as healthcare, manufacturing, industrial production and construction. Finally, some industries, including airlines, hotels, oil and gas firms, restaurants and brick and mortar retailers, experienced dramatic revenue declines.

Although a company’s industry provides a clue as to 2020 performance, it is also important to understand how COVID-19 impacted the trajectory of the individual business being valued. At Prairie, when performing a valuation, we collect five years of historical financial statements, balance sheets, income statements and cash flows for analysis. We get a sense of the company's historical growth rate, cost structure, profitability, cash flow, working capital position and capital expenditures.

In light of COVID-19, we will also review whether the company took advantage of federal stimulus options and whether this altered the company’s balance sheet or P&L statement and what adjustments, if any, should be made to the valuation due to the anomaly of the pandemic.

There are several other issues to consider when preparing a valuation and forecast in the COVID-19 era, including the following:

• If the company existed during the Great Recession and subsequent recovery, look at how the company performed, how long it took to recover and what the company’s projections were at the time. While this pandemic is impacting industries very differently than the Great Recession did, it can nevertheless be a good exercise to review the forecasting that was done at the time versus the actual recovery.
  
  
• Currently, the company may be reporting “growth” rates that are not the “normal” level. In reality, the company may not be growing to a new level; rather, it may be recovering from COVID-19-related declines – or unexpected gains. Therefore, what comes after 2020 in the forecast may not be indicative of past performance or even industry performance. When preparing a one- to five-year forecast, we suggest clients think about whether the company will return to “regular” growth, recover back to pre-pandemic levels or transition to a “new normal.”
  
  
• Look at the impact of individual customers or suppliers to your forecast. For example, is all or a portion of the customer base expected to change in light of COVID-19? Or, if your company has lost a key customer account, what impact will that have on the forecast?
  
  
• The impact of fixed and variable costs will have a significant effect on the valuation. For many businesses, labor costs are the largest cost of doing business. Therefore, if the size of the workforce changes significantly, there may be a meaningful impact on costs. Also, if offices are closed or facilities are operating at reduced capacity, the cost is generally the same as if they were running normally, which can lower margins significantly. Alternatively, during the recovery, the company may experience significant margin expansion as its revenue returns – and this can help cover costs.
  
  
• With regard to capital expenditures, some companies may choose to defer investments for the next year or two, or more, in order to preserve cash. Conversely, if a company has not been significantly impacted by the recession, it may decide to invest in an effort to prepare and potentially gain an advantage from the recovery. These types of plans should be reflected in the forecast.

In general, the impact that the COVID-19 pandemic is having on the global economy remains fluid. Although there are numerous unknowns, many businesses have learned to adapt to the “new” environment. Similarly, valuations of an employee stock ownership plan is fluid, as they consider the many factors that tell the story of how a business has operated throughout a historical year.

Listen to Tom DeSimone on the Change the Game Podcast!