The Coronavirus virus disease has upended life as we know. The value and operation of closely held businesses have not been spared. There wasn’t any effect on value for valuations as at 12/21/19, since the pandemic was not yet known preceding that date. Fast forward to March 2020, and now good, hard working people have been laid off, the economy has shut down, revenue has disappeared, stay-at-home orders have been imposed, and the future is no longer definite. So, how has COVID-19 affected the closely held business value?
Fluctuation or Decline in Profitability, Revenue, and Cash Flows
Regardless if all this is permanent or temporary, cash flow and profitability are the main driving force of business value. Businesses essentially base their standard prices on expected future economic advantages, which is the whole concept and premise surrounding business valuation. So when any of these crucial drive slumps, it’s inevitable that a business value decline will follow.
Economic Injury Disaster Loan (EIDL), Additional Debt from Paycheck Protection Program (PPP), or any other Pandemic-Related Loans
For instance, buyers may value a business enterprise at 4x EBITDA. To reach the equity value of the business, the overall debt will be subtracted from the value of the business. So if you get a PPP loan that is $2 million, it will minimize the business equity value by $2 million. Business value will be driven down by additional debt.
Business Risk Has Gone Up
Considering that nobody knows how businesses will be affected by the Coronavirus pandemic, the risk of doing business has significantly increased. Risk can be seen in discount rates used in Income Approaches to business valuation like the Capitalization of Discounted Future Cash Flows Method or the Historical Cash Flow Method. Business value goes down as the risk rate increases.
The majority of sellers and buyers are taking a wait and see mannerism considering that it’s too soon to tell the impact of Coronavirus on prospective M&A transaction values. In any deal done, financial adjustments with regard to COVID-19 will undoubtedly be part of the conversion, and those modifications will affect deal values. It is recommended that sellers offer buyers financial predictions showing the impact of the ongoing COVID-19, which will include a rough picture of what a post Corona environment will be like.
The majority of businesses who carry Goodwill and issue GAAP financial statements and Long-Lived Assets on balance sheets might find that these assets’ fair value may be stifled as a result of a reduction in overall business value because of the COVID-19 pandemic. Under ASC 350, this might be deemed a triggering occurrence and need testing in the company’s annual impairment testing dates. This may result in impairment charges.
Estate Planning Opportunities
The upside to all this is that it may be the perfect time to transfer the wealth of closely held business interests and change them to trusts or family members. The Coronavirus presents an opportunity for persons to take full advantage of low business valuation to reduce gift and estate taxes. This, coupled together with a looming Presidential election and nobody knowing what may happen to gift and estate tax exemption levels, provides an extraordinary chance for one to transfer wealth while gift and estate taxes are low.
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