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Several people have asked how business valuations differ before and after COVID. I recently co-presented with Kelly McCann, Esq. of Burnside Law Group to the Oregon Society of CPAs on the topic to more than 50 attendees. It is an important question!
First, a valuation is based on a projection of future earnings. Historical earnings are an important part of predicting future performance, but there are many other pieces. U.S., state and local economies affect business value, as does the industry of a business. COVID has made it particularly complex because it has affected regions and industries in different ways. Some businesses got a boost in revenue, some were devastated. Some business owners were able to successfully pivot, while others spent money trying to do so, only to fall harder.
How do we perform appraisals with so many unknowns? We do the best we can with what we have — the same as all business owners have been doing this year. We can only work with the information available, not with what we wish we had. We work hard to gather evidence and substantiation to paint a picture of each individual business’s prospects.
Within the company, we can usually obtain historical financials. I have rarely seen usable management projections, however, so we most often build our own. I ask owners and managers for any reports that they use themselves in their day-to-day operations and planning. How do they know how much inventory to order? How do they plan staffing levels? Although they do not have a grand master plan with organized projections, we find that they do keep track of “stuff.” In each appraisal, I dig in to learn exactly what is important to them and how they track it. What drives sales and customer satisfaction? How far out do they buy? How can we compare what the business is doing now to a year ago and the past five years? It usually takes several rounds of questions and discussions. Digging deep into each individual company is the key to understanding how they operate and how to project what will happen in their future.
There are several resources available outside the company. Most companies operate in an industry that has an association comprised for the benefit of similar companies across the nation. (i.e., I Googled “concrete association,” and I stopped counting at 20!) These associations will usually provide some information and basic benchmarks for free. This enables us to compare a subject company with its peers. Sometimes, associations will also have their own projections for their industry. If we compare how a company had done relative to its industry in the past, we can make an educated guess on how it will perform relative to the industry projections.
There are companies that analyze industries, but access to their reports is typically by paid subscription. Wonderful for us in Central Oregon — the Deschutes Public Library subscribes to many databases with rich vaults of information. I strongly recommend that business owners use this great resource to compare their performance to their industry benchmarks. You may discover some lost opportunities or areas where you can improve. Shout out to Liisa Sjoblom, one of the community librarians, who has helped us with research several times when the library was closed due to COVID restrictions!
There is a plethora of economic information available from government agencies. A small sampling includes:
- Treasury Rates: treasury.gov
- Federal Reserve Economic Data: fred.stlouisfed.org
- Bureau of Economic Analysis: bea.gov
- Oregon Employment Department: qualityinfo.org
- Deschutes County: deschutes.org/cd/page/reporting-statistics-center
It takes time-consuming work to find, sort and evaluate data to develop good projections and it is even more difficult and important since COVID. Once we have developed projections, we still have more research to conduct. Appraisals require applying a discount rate or a capitalization rate to projected earnings to bring the value of the future benefit stream to a distinct value in the present. Through more research and analysis, we determine what interest rates market participants are demanding to take on the types of risks that our subject company faces.
Once we finally have substantiated projected benefit streams and the interest rate the market requires to invest in companies with similar risk profiles, we discount the future benefits to derive the present value of the business. We then write a clear substantiated report so that the users understand how we arrived at this concluded value. Much like your algebra teacher said, “show your work!”, we clearly demonstrate how we developed the income projections and what risks we analyzed to build the discount or capitalization rate.
Yes, it is complicated, but like any complex business procedure, we break the process down into steps. We develop an opinion of value with in-depth research specific to the particulars of each company. Right now, COVID has a major impact on all markets and how it affects each individual business presents several more pieces of the puzzle. By digging in deeper than ever, we can still determine reasonable conclusions of value.
If you are looking for information specific to your business, please feel free to contact me or the Deschutes Public Library at deschuteslibrary.org. As I mentioned in my previous article, there is still an active market for businesses, despite the uncertainties we all face. If you want to talk about your specific situation, contact us for a free, confidential consultation. We are glad to help where we can or point you in the right direction!
