The ongoing pandemic continues to plague our business environment with uncertainty, raising myriad concerns regarding COVID-19’s economic impact on business enterprise value. Valuation challenges are being met in real time, as IRS Revenue Ruling 59-60  and the Standards for Valuation Services  dictate that your valuation should be based on known and knowable facts as of a specific date. Further, certain assumptions applicable in your business appraisal at one point in your company’s life cycle may not be suitable at a later date. Therefore, your valuation should include careful consideration of valuation methods, markets and industries, and company-specific risk factors. And each of these items must be thoroughly examined and documented.
Consider the Valuation Method
There are three common valuation methods for determining the value of your business enterprise: the income approach, the cost approach, and the market approach. If the impact of COVID-19 has impaired your company’s ability to operate indefinitely, then the cost approach may be appropriate. The cost approach is an asset-based approach that can derive indicated value to your company’s equity holders by looking at your company’s balance sheet. By utilizing a hypothetical liquidation scenario, a possible recovery rate for your company’s underlying assets can convert your company’s book value of equity to a fair market value. However, there are limitations to this method as the cost approach looks to historical costs instead of current fair market value.
Consider Your Projections
Your projections and assumptions should be carefully considered and well-documented during the pandemic. When preparing estimates, consider both challenges and opportunities in the COVID-19 environment to determine your business’s ability to achieve projections, such as:
- Can my company meet its financial covenants, as well as remain liquid and solvent?
- What is my company’s cash usage rate, and can my company position itself to sustain operations with reduced cash flows?
- Did we have to lay off employees, and are there layoffs that must be considered in the near future?
- In light of current market conditions, does the industry in which my company operates provide new growth opportunities?
Consider Your Industry
Specific industries, such as the hospitality and energy sectors, have felt the impact of COVID-19 more than others, due to lockdown measures and travel restrictions. In contrast, operators in the consumer staples industry and tech companies have experienced growth as consumers remain homebound. The markets and industries in which your company operates can provide insight into enterprise value but should be carefully examined during economic downturns. Under the market approach, we look at comparable businesses and transactions within the industry, which are then utilized to derive market multiples to indicate your company’s value. The multiples reflect market conditions as of the valuation date and are applied to your company’s financial metrics to produce reliable results. The market multiples should be apples-to-apples to your company’s financial metrics, as comparable financial information derived from market participants may reflect one-off events caused by the onset of the pandemic that should be excluded from your valuation.
Consider the Impact of CARES Act
For companies that received financial relief via the CARES Act, one-time events such as receipt of Paycheck Protection Program loans can alter financial metrics and cause unreliable indications of value if not given appropriate consideration. Suppose a boost of cash was injected into your company through tax provisions or stimulus loans. In that case, your company’s historical financial metrics, such as net income and EBITDA, may not provide an accurate representation of normal operations and future financial performance or position. Relief provided by the CARES Act can affect your company’s cash flows and capital structure, and may inflate your enterprise value if not addressed appropriately.
Consider Your Company’s Risk Factors
The income approach may be the most appropriate valuation methodology during an economic downturn. This approach looks to the development of your company’s income, earnings, and economic benefits, which are discounted to a present value at a point when cash flows are assumed to become stabilized through a discount rate. The inverse relationship between discount rates and enterprise value requires careful scrutiny of economic, industry, and company-specific risk factors. The latter can include renegotiations with key customers, store closures, supply-chain issues, and risks of forecast shortfalls due to business disruptions caused by COVID-19. And these factors may need to be adjusted if not already reflected in other market inputs.
There is no one-size-fits-all solution to the valuation dilemma and ongoing valuation complexities caused by the pandemic. No matter which approach is used, every company is unique and should be scrutinized individually. Your forecasts and business plans are now more crucial than ever. And there are many considerations that you must carefully weigh and scrutinize when you examine the impact of COVID-19 on your company’s enterprise value.
 Revenue Ruling 59-60, 1959-1 CB 237, Sec. 3.03.
 American Institute of Certified Public Accountants Standards for Valuation Services No. 1, VS Sec. 100, ¶ 43.