Valuation Considerations Amid a New Environment – As Shared by Arizona Attorney Magazine
By Brian Foltyn, REDW Principal and Valuation Practice Leader
Valuation professionals are regularly retained by attorneys to value a business or business interest for reasons that can include shareholder buy-outs, shareholder disputes, divorce, buy-side and sell-side transactions and estate tax planning matters. In the face of a pandemic, economic uncertainty, and the stock market hitting an all-time high, valuations were dramatically affected during 2020. This article discusses some of the top valuation questions amid a new environment and what attorneys may want to consider to best educate clients and manage their expectations.
Is a Company’s Historical Financial Performance Still Relevant?
Valuation is a forward-looking exercise to determine a company’s future, available and distributable cash flows. Pre-pandemic, a company’s normalized, historical financial performance could be a good proxy for its future. The COVID-19 pandemic, however, has affected just about every business – and the impact varies depending on industry and circumstance. The pandemic created industry winners and industry losers in 2020. Consider how the financial performance played out between the recreational vehicle (RV) industry compared to the leisure and hospitality segment. In general, RV sales were significantly up due to people seeking alternative travel because the leisure and hospitality segment was shut down. Valuations must consider whether changes in financial performance, as a direct result from the pandemic, are now indicative of a new, go-forward, normalized level – and then treat historical financial performance accordingly.
How are PPP Loans Treated for Valuation Purposes?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in early 2020, appropriated $349 billion (and an additional $310 billion one month later) of relief funding for the Paycheck Protection Program (PPP) loan program, which is administered by the Small Business Administration (SBA). Most companies applied for PPP loans. Under Accounting Standards Codification (ASC) 470, the full PPP proceeds are recognized as a liability on a company’s balance sheet – until forgiven or paid.
Typically, management teams have a pretty good understanding as to whether their company’s PPP loans will be forgiven. When it is highly probable that a PPP loan will be forgiven, it may be appropriate to eliminate the PPP loan amount from a company’s balance sheet for valuation purposes, which increases (book value) equity.
Similarly, a company’s PPP loan that has ultimately been forgiven by the SBA, and removed from the balance sheet, will recognize a non-cash gain on its income statement. The income recognized from this loan extinguishment may need to be eliminated from the income statement as part of a normalized earnings analysis, which decreases earnings / cash flow.
Management teams with concerns about PPP loan forgiveness may require valuations to consider the status and timing of the company’s application for forgiveness, assessment of documentation available to support forgiveness, and analysis of the SBA’s PPP loan rules.
How Have Valuation Multiples Changed?
Valuation multiples vary by industry and company; however, as evident by rising private company transaction multiples, overall valuation expectations are high. In the third quarter of 2020, earnings before interest, taxes, depreciation and amortization (EBITDA) multiples reported were at their highest since pre-pandemic, 2018 levels. The rise in EBITDA multiples may reflect investors’ expectations of a hopeful future that includes additional government stimulus, an effective and timely vaccine, the end of social distancing and the creation of more jobs (and more spending). These expectations could also explain why the stock market is at an all-time high during a recession.
Notwithstanding the above, strong valuation multiples, given the uncertainties inherent in today’s environment, are contending with several new challenges. These include extra scrutiny regarding COVID-19 add-backs, working capital requirements, required rate of return and capital structure.
What is next?
Performing valuations during a pandemic has created new challenges and issues. As I write this article, the United States is beginning to roll-out the COVID-19 vaccines – and this could spur a strong economy and job growth in 2021. As we enter the new year and begin to recover, valuations should be dynamic and changing to reflect the current economic environment and outlook.
This article appeared in the March 2021 issue of Arizona Attorney Magazine. Reprinted with permission.