It’s hard to witness the sudden volatility in the stock market without a sense of panic and dread. The coming recession is inevitable, but how will changes for large companies affect small to medium-sized private businesses? This is a fluid situation, and no one knows for sure, but we do know one thing: valuations always rely on estimates and sound judgment. The impacts of this crisis will affect valuations, and sway the factors analysts look at. Some factors which will be relevant include:
- Where is the business’s primary location of operation?
- Can the business continue to provide products and services during a pandemic?
- What industry does the company operate in?
- How long will COVID-19-related disruptions last?
- How diverse or concentrated is the customer base, and are the business’s customers likely to face economic distress?
- Will the crisis require different management of
- Must the company defer capital expenditures?
- What must the business do to pay debts?
- Has the company applied for or received government assistance?
- Was the company highly leveraged prior to the pandemic?
For almost all companies, it will come down to assessing the impact of the crisis on short and long-term finances, in addition to evaluating the company’s financial health prior to and following the pandemic. Valuation experts typically look at discounted cash flow (DCF) when assessing the value of a company. DCF can illustrate the likely impact of COVID-19 with the right information, including estimated future cash flow, long-term growth expectations, and the cost of capital or discount rate.
Macroeconomic conditions will affect the M&A environment even for a business that is otherwise thriving. There may be limited access to capital, shifts in foreign exchange rates, and changes to credit and equity markets. Of particular importance will be deterioration in the niche or geographic region in which a company operates, as well as increased competition, a decline in demand, or a heavily regulatory environment.
Cost, too, figures prominently. If supply, labor, and other costs decrease, this will negatively impact profits and cash flows, with potentially harmful impacts on M&A, too. Overall financial performance is always critical to valuation. Negative or declining cash flows, or a decreased in projected or actual earnings—especially compared to prior projections—will lower value.
A change in management, strategy, customers, or key personnel can affect value. Whether that effect is positive or negative depends on the projected outcome of these changes. Pay close attention to a lost of brand recognition and respect or declining goodwill. A sustained decline in share price, especially relative to comparables, warns of a decline in value, especially when it is related to other changes in business operations.
Owners in the current climate must be willing to critically assess the value of their company, then take proactive steps to increase and protect value. Buyers despise risk. Strategies that protect your business in an uncertain environment can drive value, especially when competitors are unable to implement such strategies.