Gary R. Trugman wrote in his tome Understanding Business Valuation, A Practical Guide to Valuing Small to Medium-Sized Businesses, Second Edition beginning on page 510 the following:
Valuation as of a Specific Date
A business valuation is similar to a balance sheet, as it is a picture of the business at a specific moment in time. Values change as factors around the business change. This is especially evidenced in the public stock market. Therefore, the information used in performing a business valuation should be only that information that was known or knowable as of the valuation date. This can best be illustrated by a real situation that I encountered. A valuation of a bicycle shop was to be performed as of June 10, 1992, the date of the divorce complaint. The business burned down on March 14, 1993. In this instance, the value as of June 10, 1992, was the real issue. An appraiser cannot forecast a fire nine months after the valuation date.
After speaking with many other professionals, I have come to the conclusion that if we are preparing a valuation as of December 31, 2019 we should not consider the impact of the coronavirus on the historic financial statements, which is definitely a subsequent event. There is no way the impact of the coronavirus on the U.S. economy and the stock market was known or knowable as of that date.
Dec. 31: China tells the World Health Organization’s (“W.H.O.”) China office about the cases of an unknown illness.
Jan. 9: China announces it has mapped the coronavirus genome.
Jan. 21: The U.S. Centers for Disease Control and Prevention confirms the first coronavirus in the United States.
Jan. 23: Wuhan and three other cities are put on lockdown. About this time, approximately five million people leave the city without being screened for the illness.
Jan. 30: Amid thousands of new cases in China, a ‘public health emergency on international concern’ was officially declared by the W.H.O. China’s Foreign Ministry spokeswoman who said it would continue to work with the W.H.O. and other countries to protect public health, and the U.S. State Department warned travelers to avoid China.
Feb. 2: The first coronavirus death was reported outside China.
Feb. 7: The Chinses doctor Li Wenliang who tried to raise alarm died after contracting the disease.
Feb. 14: France announces the first coronavirus death in Europe.
Feb. 21: A secretive church is linked to the outbreak in South Korea.
The virus appears in Iran from an unknown source.
Feb. 23: Italy sees major surge in coronavirus cases and officials lock down towns.
Feb. 24: Iran emerges as a second focus point of the virus.
Feb. 26: Latin America reports its first coronavirus case.
Feb. 28: Sub-Saharan Africa records its first infection.
Feb. 29: The U.S. announces its first coronavirus death and institutes travel restrictions. U.S. officials approve widespread testing.
Mar. 13: President Trump declares a national emergency.
Mar. 16: Latin America begins to feel the effects of the virus.
Mar. 17: France imposes a nationwide lockdown. The E.U. bars most travelers from outside the bloc for thirty days.
Mar. 19: For the first time, China reports zero local infections.
Mar. 21: Hawaii’s governor orders a mandatory 14-day quarantine to arriving visitors and residents.
Mar. 23: Prime Minister Boris Johnson locks Great Britain down.
Mar. 24: India, a country of 1.3 billion, announces a 21-day lockdown.
From the above, we are able to see that a national emergency wasn’t noted until almost two and one-half months past the 2019 yearend. So what do we do moving forward in time?
We certainly have to take into account the impact on the U.S. economy but to what degree and on which industries. As is the instance with any emergency, many businesses will be adversely affected while many businesses will not be affected at all and maybe even flourish beyond historic measures. Some of these businesses are as follows:
Therefore, it will be incumbent on us to ascertain explicitly (to cite some): (1) how and to what degree the company was affected?; (2) how long it is expected to attain pre-virus levels?; (3) will the company be able to recover at all?; (4) how much money will be required to facilitate the re-growth of the company?; (5) can the company even prepare a forecast to be utilized in a DCF?; (6) would we have to concentrate on the value of the adjusted equity of the business?; (7) are we only able to consider the capitalization of earnings method with growth into the next year?; (8) will we have to consider additional items and/or accounts to normalize?; (9) how long will it take to reopen?; (10) how long will it take to re-staff?; (11) understand that unemployment costs may increase because of layoffs as well as other expenses; (12) understanding the impact on the business due to the new law passed by Congress; (13) do we “stop” at Dec. 31, 2019 and not consider the present economic circumstances if the company can get back up to speed in a short period of time?; (14) are we even able to consider market comparable transactions; and (15) inspecting either the checkbook and/or credit cards for extraordinary personal expenses paid by the subject company?
If we are able to concentrate on the discount rate to determine the capitalization rate, I feel that we need to pay more attention to the Company Specific Risk analysis portion of the discount rate. This is the section “that we own.” It is imperative that we analyze and evaluate the “new” strengths and weaknesses of the business like never before. Therefore, consider for the company these possible stress (risk) factors:
- Not able to obtain financing or a level of financing that was enjoyed in the past
- The lender may require a shorter time frame for the return of the amount loaned
- Additional covenants may be imposed that may stricter than before
- The ability to still purchase from suppliers either because they won’t be sold to or the supply chain has dried up
- They may have lost revenue to other companies
- Interest rates that seem to be low may be actually higher due to some supposed risk
- The possibility of liquidation due to the lack of ability to recover quickly
- Stability of the particular industry
- The Company’s ability to rehire employees that were laid off
- The Company’s ability to train new employees and get them to an optimum level quickly
- The Company may have to change the way they provided fringe benefits or implement ones that were never given before
- Understand that employees may cost more not to make-up for the time of lost wages (could be accounted for in a DCF but not in a capitalization of earnings)
- Dependence on the Company’s particular economy; notwithstanding the country’s economy as a whole (it could be regional, state-wide and/or national in scope)
- Stability of earnings and how long will it take for the Company to enjoy the level of earnings it obtained pre-coronavirus
- Determine if they were able to diversify (i.e.; specialized medical equipment and/or supplies) and if this new product line is something that would be sustained into the future
- Determine if abnormal present or pending competition has emerged
- Understand if there are pending lawsuits (i.e.; wrongful termination)
- Understand if special environmental problems now exist (i.e.; along with possible retooling via a new diversification)
- Understand that the new diversification may be “seasonal” in nature or not long-lived and not sustainable
- Understand if new pending or initiated pending local and/or state regulatory laws have been implemented
- Understand that the business model may have drastically changed
- Understand that they may have decided to rely on the Internet more heavily than before and the risk associated with that new line of business versus companies that already command the space
- If they were already on the Internet, has their distribution and logistics structure been compromised?
- Determine if the Company’s customer base has changed or diminished
- Determine if the Company is now able to serve the area in which it operated in the past
- Determine if the “brain-trust” (management) is able to accept what has happened to the business and is able and willing to finance with increased effort and time for the Company’s future
It is quite understandable that the previous sections of risk factors seem to cross each other, but they are presented as a guide to your thinking knowing that you will give credence to them in the correct section of your valuation during this period of financial upheaval.
As long as we strive to consider all that is before us, our business valuations will be reasonable correct rather than horribly wrong!
Mr. Rudich is the Founder of the Business Valuation and Litigation Support Services company Business Valuation Group, LLC. His responsibilities include valuations of closely held and publicly traded companies, machinery and equipment appraisals, strategic business planning, budget and forecasting services, business consulting, business loss computations, depositions, and court testimony.
Ron has written five white papers; (1) Multiple Uses of Comparative Industry Data, published in IBA’s Business Appraisal Practice, Third/Fourth Quarter 2015, (2) Why Valuation Experts Should Not Use the Term ‘Nonmarketable’, published in Business Valuation Update, September 2015 by Business Valuation Resources, LLC, (3) Rudich DLOM Verification Formula, published in IBA’s Business Appraisal Practice, 2013 Third Quarter, (4) Valuing the Difference Between Voting and Non-Voting Shares of Stock, published in Business Valuation Update, November 2010, and (5) Analyzing the IBA Database Transactions Results, published in the Business Appraisal Practice, Winter 2006/2007.
Mr. Rudich was named a “Business Valuation and Financial Forensic Master”, as part of the National Association of Certified Valuators and Analyst’s Industry Titans awards at their June 2016 Conference. He was selected into the Founders Circle of the of the Alliance of Merger & Acquisition Advisors in January 2013, elected to the Advisory Board in 2004, and received the 2008 Chair of the Year award in January 2009. He was admitted to the Westlaw Round Table Group, Washington, DC expert network as a Round Table Scholar in January 2009 and recognized by SmartCEO as one of the Top CPAs in the Baltimore/Washington, DC area in their September 2008 issue.
For the Institute of Business Appraisers, he was elected as Chair of the Board of Governors for a two-year term in June 2012 and appointed to the Board for a three-year term in June 2011, appointed as Chair of the Accredited in Business Appraisal Review (ABAR) Appeals Task Force that provides technical guidance and support on ABAR reviews as of January 2011, and was a report reviewer for the Quality Review Committee (QRC) for those seeking a credential certification from 2008 to 2016. He may be reached at Ron.Rudich@bvgllc.com