Valuation Considerations under COVID-19

Most small and medium size enterprises have experienced a significant deterioration in their business as a result of the unprecedented impact of COVID-19. While some of this deterioration may be tied to temporary factors, in most cases the economic damages are long-lasting or even permanent.  Given the gloomy outlook, SMEs must reevaluate and validate their business model in order to survive and stay relevant. The true impact of the crisis is difficult to estimate given the severity and the time required to recover.

As a result, valuing a business has become even more difficult as a result of the pandemic and the recent significant decline in global equity values.  The uncertainty of the impact of COVID-19 on enterprise earnings and cash flow has resulted in increased financial risks and liquidity issues given:

  1. Equity markets continue to experience high volatility
  2. M&A transactions have been deferred or even cancelled
  3. Capital raising has been put on hold

Key inputs to valuation models, such as cash flow forecasts and discount rates are likely to change.  The increased uncertainty, and risk associated with earnings and cash flow projections, will need to be accounted for the current and future impact of the virus. Greater uncertainty results in increased risks and therefore critical valuation adjustments may need to be made:

  1. Cash flow projections – Cash flow represents one of the key value drivers of a business and now under the pandemic, cash flow has become even more critical to most businesses no matter in what industry they compete.
  2. Discount rates – Discount rates using historical data may be inaccurate under the current environment or outlook for the business going forward.
  3. Discount for lack of marketability – Given the current market uncertainty, it is expected that the DLOM applied would be increased to reflect these conditions.

Traditional valuation approaches need to be carefully re-assessed under the current environment. No one really knows for how long can businesses endure under the current situation and more importantly, in what financial condition will they be in once the pandemic is over.

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