Valuing businesses in challenging times

Our experts explore what it takes to value a private company in today’s environment.


by Jonathan Thornton and Richard Hill

Due to the economic impact of COVID-19, valuing private companies has become more challenging. With ongoing uncertainty testing the application of traditional approaches, two of our experts explore what it takes to value a private company in today’s environment.

Jonathan Thornton, a managing director in our Transaction Services team and Richard Hill, an assistant manager in our Corporate Finance team explore. 

In the past, various methods of valuing private companies have become established as standard. However, the current environment is very far from normal, and the Coronavirus (COVID-19) pandemic is effectively challenging the application of traditional valuation methods.
 
Valuation methods in the current climate 
One of the most commonly used valuation methods is discounted cashflow (DCF), which is based on discounting the future expected cashflows of a business.
 
The biggest challenge for many businesses in the current environment is establishing what future cashflows are likely to be. This is especially true with, for example, businesses in the hospitality sector. Not knowing what future lockdowns or other restrictions may be placed on the business makes it very hard to forecast.
 
This uncertainty regarding the future also leads to an additional return required by the market in order to justify the additional risk (the ‘market risk premium’). The additional risk premium increases the discount rate and therefore creates downwards pressure on valuations.
 
An alternative to a DCF is to value a company based on the multiples of profits at which transactions involving comparable companies have taken place. This method is also more challenging, given the relative paucity of transactions in recent months and the number of accelerated M&A processes where transactions may have taken place in distressed or fire sale situations.
 
Whether valuing a business based on its future cashflows or profit multiples, understanding the underlying sustainable profitability of a business is more important than ever. In the course of our work, we’re increasingly hearing the term ‘EBITDAC’ - earnings before interest, tax, depreciation, amortisation and the impact of COVID-19. The latter is very subjective, could be positive or negative and requires an assessment of to what extent things will return to ‘normal’ post COVID-19. For example, demand for office space or business travel may return to some extent post COVID-19 but almost certainly not to their pre COVID-19 levels.
 
What does this mean for owners looking to sell?
So, what does the difficulty of establishing valuations mean for business owners who are looking to sell at this point in time? Typically in an economic crisis, we see an increase in the gap between the price that sellers of businesses think that they can achieve and the price that buyers are actually willing to pay. That gap has widened as a result of this current crisis, but it may be possible to bridge that gap. For example, the use of earnouts and deferred consideration allow buyers to reduce the risk they are taking on, and the seller to participate in any upside. We expect these to be used even more frequently in the future. 
 
For strong companies that can demonstrate financial fortitude, we are seeing resilient valuations and significant interest from potential acquirers. Investors are still seeking returns on their uninvested funds and require investment opportunities to generate returns for shareholders.
 
Some industries are seeing enhanced deal activity of course – Technology, Media and Telecommunications especially, as well as anything that takes business online and away from bricks and mortar.
 
Notably, buyers are putting enhanced premiums on those businesses with recurring or repeating revenues in business-to-business spaces and being highly cautious on consumer and discretionary spend businesses or ones which rely on big one off sales, as these are harder to get customers to sign off on in the current uncertain financial world.
 
Is now the right time to sell?
Despite the challenges involved, businesses may have very sound reasons to sell now. One of those reasons is the government’s potential change to Capital Gains Tax (CGT). The scrapping of the Autumn Budget may have put that change on hold for now, but it could still be on the cards. With that in mind, selling a business now could make sense for business owners who want to avoid the risk of taking a bigger hit from CGT further down the line.
 
In addition, there is now an appetite among investors to do deals. Back when the pandemic first began, many private equity (PE) investors were firmly focused on looking after their existing portfolio companies, to make sure they would survive the crisis and provide help where needed. However, with portfolios generally settled, things have moved on and deals are now happening. The PE firms have plenty of dry powder ready to invest, and there will be some attractively priced opportunities out there – particularly among distressed companies – for players with the power to move quickly.
 
Get in touch with us to find out more and have a look at the webinar we held earlier this year for further information on how you should approach business valuations during uncertain times:
 
View our webinar
 
We will also be releasing another piece on valuations in the coming weeks from the perspective of our Forensic Accounting and Investigations team.

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