The Impact of COVID-19 on Business Valuations

BY DONALD KAISER, CPA, McCARTHY & COMPANY

The coronavirus pandemic has impacted everything and everyone. Businesses are closing, being sold or merging into other companies. Valuations are being impacted by instabilities in the economy as well as government mandates and legislation. It is important that CPAs keep current on how laws such as the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Consolidated Appropriations Act affect a valuation.

FACTORS TO CONSIDER

Valuators must consider the following factors:

* Valuation date. Valuators need to consider the timeline of the coronavirus outbreak in the U.S. and what was known or knowable as of the valuation date. Most experts agree that little was known about COVID-19 as of Dec. 31, 2019, so it should not be considered in the valuation. By January, more news was available about the coronavirus spreading to the U.S., so it could be considered. As of March, it was a certainty and should be reflected in the valuation.

* Subsequent events. Subsequent events related to the impact of COVID-19 on the company’s value should be disclosed in the valuation report. Valuators should include a timeline, explanation of each event and its impact on the performance and value of the company.

* Valuation methods. Three methods are used to value a company: income approach, market approach and asset-based approached. Since COVID-19 caused an economic disruption, a valuator may consider using the discounted cash flow (DCF) method which is an income method. DCF studies the future performance of the business each year until conditions are no longer affected by COVID-19. When conducting a market approach and comparable companies benefited from provisions of the CARES Act, valuators need to consider how that alters their multiples.

* Cash flow. Valuators look at the company’s cash flow to determine if there is enough money coming into and going out of the business to maintain operations. This is especially important now that government mandates are impacting businesses. The valuator must consider how long the company can continue under the uncertain conditions caused by COVID-19.

FINANCIAL PROJECTIONS

No one really knows how long the pandemic will continue. A key consideration is near- and long-term financial projections. Valuators should run different scenarios to try to project what might happen if the coronavirus is under control in three, six, nine and 12 months, as well as one, two and five years into the future.

FINANCIAL REPORTING

Impairment or the permanent reduction in the value of a company’s assets needs to be considered. Valuators should study how COVID-19 impacted fixed assets and intangible assets such as goodwill, brand recognition and intellectual property (patents, trademarks and copyrights). Long-lived assets or any asset the business expects to retain for at least one year must also be studied. ASC 350 requires an entity to consider whether an interim “triggering” event has occurred. If so, a quantitative analysis would determine if the carrying amount of goodwill exceeds its implied fair value.

INSIGHT FROM THE AICPA

Last June, the AICPA issued insight on valuing a business affected by COVID-19. Frequently asked questions (FAQs) were developed to help CPAs and valuation professionals make adjustments based on the CARES Act and other legislation.

The FAQs address provisions that professionals should consider when evaluating businesses that received funding or support under the CARES Act. This includes the Paycheck Protection Program (PPP), Emergency Economic Injury Grants/ Economic Injury Disaster Loans (EIDL) and the Small Business Debt Relief Program.

As explained by the AICPA, provisions of the CARES Act have the potential to create one-time events that alter income and market inputs to value. The FAQs detail these issues and steps for valuation professionals to consider in the current environment.

In addition to discussing the impact of tax law changes on valuation, the FAQs specifically cover how the PPP, EIDL and other short-term small business support provisions could impact valuations, such as PPP loan forgiveness.

The FAQs are intended to provide a consistent approach. The AICPA suggests practitioners also rely on their experience and professional judgement. Visit the AICPA’s coronavirus resource center (aicpa.org/coronavirus) and the Valuation Services COVID-19 resource page (future.aicpa.org/topic/valuation-services/ covid-19-valuation-services) to learn more.

Donald Kaiser, CPA is a principal with McCarthy & Company, a leader in construction accounting. He is a member of the NJCPA and can be reached at Donald.Kaiser@MCC-CPAs.com.

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