by Tony Carter
A little over 12 months ago during the first round of COVID-19, I penned an article discussing the importance of what is ‘known or knowable’ as at the valuation date.
At the time, COVID-19 was called a once in a 100-year event, but a year later we are coming out of what for many has been the strictest lockdown period of all, and the impact of COVID-19 on SME business valuations should still be front of mind.
The Future Maintainable Earnings Method
The most common method of valuing SMEs is Future Maintainable Earnings. This method is preferred over those that require a reliable forecast of future cash flows, as most SMEs simply don’t have such a forecast.
While the Future Maintainable Earnings method has always had its limitations, COVID-19 has introduced another in that the starting point in determining Future Maintainable Earnings is to look at the recent historical financial performance. However, that means working with COVID-19-affected historical performances in the 2020 and 2021 financial years, and now also into the 2022 financial year.
Effects of COVID-19 on Business Valuations
When assessing the value of your business, it is important to take the time to look at the effects of COVID-19, rather than taking the historical performance alone as gospel. It is equally important to do this when a valuation report is being prepared as expert evidence in Family Law and similar matters.
Here are some examples I’ve encountered recently of the real-world effects of COVID-19 on businesses that may affect your business valuation:
- Restaurant/pub experienced significant restrictions in trade in 2020 and 2021 but future earnings are promising (with possible limitations on capacity)
- Travel agent essentially ceased trading, and short-medium term future earnings are likely to be inconsistent. The longer-term future earnings are dependent on the owners positioning themselves for a post-lock down surge in demand (especially as international recreational travel opens up)
- Independent butcher experienced a significant increase in demand and earnings over 2020 and 2021 and this is likely to continue, provided new customer loyalty can be maintained
- Secondhand car dealer experienced a decline in earnings in 2021 due to supply issues, but future earnings look to return to pre-2020 levels as supply is likely to rebalance over time
- Retailer experienced restrictions in trade in 2020 and 2021 and future earnings are not likely to return to pre-2020 levels in the short term due to customers adopting online purchasing habits.
In addition to industry-specific effects, almost all businesses I have valued over the last year have included in their historical financial performance some form of COVID-19 government support revenue. Adjustments to historical performance or even the adoption of other valuation methodologies may need to be used when valuing a business experiencing these effects, and missing these adjustments may result in a material undervaluation or overvaluation of your business.
How We Can Help
If you would like to know more about valuing a business that has been affected by COVID-19, please contact Tony Carter in the form below of call 02 4969 6600.