Stock markets around the world are plummeting, with the S&P 500 index falling by over 20% since the start of March.
In most cases, the outlook for the underlying business is negatively impacted by the global ‘lockdown’ resulting from the Covid-19 pandemic. Even in cases where the underlying business outlook remains positive, prices have fallen due to changing investor sentiment.
In essence, business owners / entrepreneurs trying to sell their business will likely be hit with the double impact of reduced profitability forecasts and lower prices. While it has serious negative implications for those currently seeking a sale, other businesses will also be impacted. Many businesses will have banking covenants that stipulate a minimum Loan to Value (LTV) which must be maintain. In other cases, a business which has investments and intangible assets on its balance sheet may be required to carry out impairment testing to assess if the Fair Value of these has reduced.
In times of uncertainty, valuation multipliers tend to be poor indicators of the price achievable for a business if it was placed for sale. Since these multipliers are generally expressed as a multiple of past earnings etc.; they are not very functional where past performance cannot reasonably be used to predict future performance.
Discounted Cash Flow based valuations are a preferred method for estimating business valuations as they consider both the updated trading outlook of the business and the changed investor attitude across various sectors (which is reflected in the Weighted Average Cost of Capital).
While investor sentiment is outside the control of a business owner, it is possible to take control of the valuation conversation by ensuring the preparation of a robust and thorough business plan; mapping how it will navigate the current crisis and how likely the business is to emerge when the crisis is over.
Ultimately, it is the future cash flow of the business that an investor is purchasing and, therefore, the greater comfort that you can give them that you have identified a plan to manage the knowable risks, the stronger a position you will be in to negotiate a satisfactory price. The same applies if you are seeking funding from finance providers - the more clarity you can provide regarding future cashflows, risks and valuations; the better and easier it will be to access finance.
The key questions that businesses need to consider are;
- What are the key drivers of value for your business;
- What underpins sales volumes?
- How are prices set?
- What are the largest costs and what impacts on these?
- What will the likely impact be in the short / medium / long term;
- Will sales volumes be down?
- Will you have to reduce prices in order to stimulate demand?
- How will your supply chain be disrupted by the crisis and what will the implications of this be?
- How are we going to prepare and deliver our cash flow projections?
In uncertain times it is prudent to prepare several scenarios; including a best-case and worst-case scenario. Having completed this, it’s important to take a step back and assess the implications of your findings. It may reveal a short term cash deficit that will need to be financed either from existing business resources or through external finances. It may also highlight that the business is likely to experience difficulties meeting its current banking covenants. Not only would this negatively impact on the value of a business (as cash flows in the near future have the greatest impact on net present value calculations), but also an investor may sense an opportunity to negotiate a low price due to your ‘distressed’ situation. In this circumstance, it may be preferable to implement a plan to bring the business back to a cash positive position before seeking to sell.
On the other hand, if it becomes apparent that the type of short-term funding required is not available, a decision will need to be made whether or not to sell the business to a capable party who can fund the short term deficit and save the business.
At BDO Corporate Finance we have a multi-disciplinary team experienced in advising clients on the current valuation of their business and how to maximise this in a turbulent economic environment.
Our Valuation and Financial Modelling Centre of Excellence specialises in the preparation of detailed financial models; including cash flow forecasts that can help you to make more informed decisions in uncertain times. For more information contact Brian Haugh at [email protected].