Business Valuation: The Covid-19 Impact
The Covid-19 pandemic has sent national economies around the world into a tailspin.
Equity markets are taking a hit as company values fall due to perceived increased risk and lower projected future earnings. We are seeing wild swings across all market indices as investors try to divine these impacts.
This effects us directly – business brokers, sellers and buyers – because of the fact that the equity markets are where the funds for a majority of small and lower Middle Market business acquisitions come from. That impacts available capital; whether there is enough liquidity in the market to make an acquisition.
But the other concern is valuation – and that concern is not limited to public companies. From the local bakery and automotive service center to the corner convenience store and regional marketing firm, this impacts private companies even more significantly.No one knows when the end of this threat will be in sight, let alone how long it will take businesses to recover – or how rapid that recovery will be.
The ramifications of this virus for businesses in general – and small and lower Middle Market businesses in particular – are impossible to state with any confidence. This has caused most buyers to put their acquisition plans on hold. How quickly these buyers get back in the market will depend on how long and how deep the downturn is.
Because of Covid-19, there will be business failures, especially in industries such as tourism, hospitality, event management and entertainment. The restaurant industry alone – a perennial deep vein for business brokers to mine – is getting clobbered.
In the United States, the spike in the number of unemployed over the past two weeks has been beyond anything that has ever been seen in this country – and the fear is that the numbers as of last week don’t reflect the reality of what is about to start appearing as more and more people find themselves out of work due to sickness, shelter-in-place orders or closing of their employer. More than 10 million workers filed in the past two weeks alone. The follow-on effects will impact us all. No one – and no business – is immune.
Given the heightened levels of anxiety and uncertainty, buyers are apprehensive. In this environment, historical financial performance of a business may not necessarily be a useful guide to future earnings. It will take time for buyers to feel the confidence necessary to pull the trigger on most acquisitions.
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Covid-19 and Sellers
As for sellers, they must consider the negative impacts on their earnings and the uncertainty of what the future might look like for their business. If they own a restaurant supply company, how many of their current customers will be in business in six months?
Buying or selling stock in a publicly-traded company is an investment decision that is made based on the target company’s recent earnings and the likelihood that those earnings will grow in the future. Buying or selling a private business – from the flower shop to the widget manufacturer – is no different.
As a rule, business buyers like to see at least three – and preferably five – years of relatively stable earnings, or better still, earnings growth to have confidence that, should they buy, there’s a reasonably high probability that such profits and growth will continue. Given the existing business environment, even with attractive numbers for the past three years, it is almost impossible to instill the necessary confidence in the buying public for at least the near term.
If a business cannot instill that confidence, it will be difficult to sell. And its value – at least temporarily – is likely to be much lower than it was even three months ago.