The COVID-19 pandemic has prompted the U.S. government to provide financial relief to millions of businesses and individuals alike, in hopes of stimulating a deteriorating economy. If your company received a Paycheck Protection Program (PPP) loan, you can expect loan forgiveness after meeting certain requirements—but you might not know yet whether your government loan will be forgiven. Consequently, your balance sheet may reflect large loan balances and possibly even large cash balances because of your PPP loan.
The question now is: How could this impact the value of your company?
Uncertainty Surrounds PPP Loan Forgiveness
The Coronavirus Aid, Relief, and Economic Security (CARES) Act has offered relief to many small businesses through federal PPP loans. To receive a PPP loan, companies have had to meet certain eligibility requirements and to certify, in good faith, that their loan request was necessary because the business was suffering as a result of the pandemic.
After the PPP loans were disbursed, you likely had to think about how to use those proceeds in order to qualify for full loan forgiveness. But amid uncertainty related to the criteria and application process for loan forgiveness, including what documents to submit and how the overall timing works, your company may be among the many that are still awaiting approval—or that are simply unsure of how to account appropriately for the PPP proceeds.
Accounting Has an Impact on Your Company’s Value
Once your PPP loan was approved and your company received the funds, you initially accounted for those funds as a loan. As you consider whether your company meets the criteria for loan forgiveness, part or all of your PPP loan proceeds should be accounted for as debt, a government grant, or a combination of both. Given the uncertainty around loan forgiveness however, you may be unsure how your company should appropriately account for the PPP proceeds.
When determining the value of your business, valuation professionals must consider adjustments to your company’s balance sheet and/or income statement to account for nonoperating assets or liabilities and for nonrecurring or one-time items.
To understand adjustments for a PPP loan and its impact on your company’s value, these professional appraisers must consider what is known and knowable as of the valuation date. Appraisers will request certain information—at a minimum, documentation to support the PPP loan balance and the status of the loan forgiveness application, as well as documentation that demonstrates satisfaction of forgiveness. Upon considering this information, and based on discussions with your company’s management, appraisers will use their professional judgment to determine whether making an adjustment to the financial statements for the PPP loan is reasonable.
If you believe loan forgiveness is likely for your company, and if you have sufficient documentation to support this claim, it would be reasonable for the valuation professional to adjust the PPP loan from the balance sheet as of the valuation date. In some instances, however, there may be little or no support for forgiveness—in which case the appraiser may determine that the loan balance should remain on the financial statements.
If your PPP loan is forgiven, and your company removes the loan as debt from the balance sheet, you may recognize income due to the extinguishment of debt. Will this result in an increase in your company’s value? As with many questions in valuation, the short answer is: it depends. Were the funds truly necessary, or were they used to increase cash or pay down debt?
Perhaps your company will use the excess cash for investing in growth strategies to help you regain results that were lost due to the pandemic. An increase in cash (or a lower debt balance) could result in an increase to your company’s equity value. But simply maintaining a cash balance that offsets the PPP loan balance—or instead using the funds to maintain normal operations, make payroll, or fulfill other essential obligations—may have no meaningful impact on your equity value.
If your company does receive forgiveness of your PPP loan, or if you believe forgiveness is highly probable, you will likely recognize income on your financial statements—although this would amount to artificially inflated earnings, and appraisers would want to adjust this one-time gain to “normalize” earnings for the year. The value of a business is driven by its ability to generate future cash flow, and your company would not expect to achieve a nonrecurring item in future periods. Therefore, in determining value, the income should be removed from the cash flow stream.
Finally, if all or part of your PPP loan is not forgiven, your company will record it as debt on your balance sheet, and this could indeed reduce the equity value.
There Is No One-Size-Fits-All Approach to Valuation
A PPP loan, regardless of whether it is approved for forgiveness, could impact the value of a privately held business. Unfortunately, there is no one-size-fits-all approach to the valuation of a business that has suffered during the pandemic and received a PPP loan. With no best practices available as guidance, the actual financial impact of a PPP loan will vary based on the facts and circumstances surrounding your particular business. Appraisers will carefully consider all aspects of the PPP loan balance, as well as any offsetting cash balances in the PPP account that might impact value. In determining the correct approach for your company, be sure that you do the same.