It would be hard to deny that COVID has not had a significant impact on all of our lives. We have addressed how the pandemic might impact the valuation of companies. The first obvious impact is how it will impact clients and their ability to remain in business. We have tracked the revenue of several businesses on a month-to-month basis in 2020 versus 2019. The results of those reviews have been inconsistent.
The second possible impact on company valuations is that we could see a reduction in deal multiples. We have had discussions with several parties and the consensus is that the demand for companies is keeping the multiples at historic levels.
The third possible impact is how potential Buyers might structure a deal. Transactions are normally based on a multiple of historical revenue or earnings. Without knowing the extent of the impact of COVID on future revenue or earnings, we expect that Buyers will become more conservative on the percentage of the transaction value paid at Closing.
Sukay & Associates gets involved in a variety of subjects that interest business owners. If we could only discuss one topic with potential clients, they would almost unanimously want to discuss the value of their company. We are asked this question all the time. It would be nice if there was a simple method used to value all businesses. The reality is that few companies are alike. As a result, their value will vary widely.
Our initial response to this question is that it is impossible to estimate value without performing a financial analysis. Earnings are the number one factor influencing value. The value of a business is a factor of the earnings of the business times an earnings multiple. Frequently, a business owner will focus on the multiple. We try to have a discussion on the earnings. Once we establish baseline earnings, the discussion then switches to the earnings multiple.
Multiples are based on a variety of factors including market influences. Just like the stock market where the value of a company can go up or down even though the earnings remain constant, business multiples fluctuate. We will save the discussion on market influences for another day.
Value is also dependent on the purpose of the valuation. The most common and most recognized value is the value that a business owner should expect to receive from an independent third party. A business would have a separate value if the valuation was performed for the purpose of an internal perpetuation or the valuation of shares for an Employee Stock Ownership Plan (“ESOP”). In this discussion, we will focus on the value that a business owner should expect to receive in a sale to a third party.
In order to establish an estimation of a company’s value, we have established a series of “Factors that Influence Value.” These factors include:
- Size of the business
- Age of the owners
- Type of business
- Owner involvement
- Growth rate
- Profit margins
- Specialty lines of business
- Geographic location