How Did 2020 Change Valuations in M&A
By Cheryl Aschenbrener, National Leader and Partner, Transaction Advisory Services
To say that 2020 was an unusual year is an understatement. Especially within the transaction world, where it left more questions than answers, like: How do buyers and sellers treat 2020 numbers in the valuation process?
In more normal times, an appraiser would look at a prospective seller’s prior three years of operating income, maybe longer depending on the economic cycle. There would be adjusted EBITDA times X calculations with the aim of bridging past to future—painting an accurate picture of a company’s earning ability and risk going forward.
It all works reasonably well, until you toss 2020 into the mix.
Nonetheless, during hard times—as proven this past year—businesses are more resilient to unique hardships and new challenges than you might anticipate. In this article, we’ll share some not-so-obvious considerations to keep in mind when it comes to getting the right perspective—and dollar amount—in buyer and seller valuations.
Looking Past the Numbers
Some valuation and transaction experts suggest simply ignoring 2020 altogether. Just start at 2019 and work back from there. Or better yet, work from projections going forward. These projections will embed the changes made by the company during COVID, embracing new lines, methods or markets, and will detail how they return to or exceed pre-COVID results.
In calculating how 2020 may affect future performance, context matters for every company. Some restaurants, for example, took a huge hit and may struggle to recover. Others ramped up their takeout service and hosted virtual happy hours. Brewers and distilleries generated revenue by bottling and selling hand sanitizer. Home exercise equipment and home-office furniture companies had banner years.
In short, the pandemic affected every business differently, so blanket approaches to valuation won’t work. And while it’s wise to take 2020 numbers with a giant grain of salt, stories of resilience and risk speak volumes about a company’s potential to succeed. This resiliency brings value to the table going forward and is an essential part of the analysis.
Sellers who adapted quickly and seized new opportunities need to bring these stories to life in any valuation. The risk on future returns for these businesses are inherently less than for those who had chances to pivot but did not. Buyers should be on the lookout for stories like these.
Timing is Everything
You might think that such uncertainty and change would put a freeze on transactions. However, transaction volume is actually hitting record numbers right now. The reasons are manifold:
Interest rates have never been lower. It’s a great time to borrow money, so sellers will find an eager market.
Pools of investment capital have never been bigger or more numerous.
Many boomer-aged company owners who have been thinking of selling are now ready to cash in their chips, especially after such a tough year and as a way to manage their Paycheck Protection Program (PPP) balances.
Regulations affecting the capital gains tax could change soon, and many sellers are motivated by this ticking clock.
The PPP Factor
Here’s another wrench in the 2020 valuation equation: the federal PPP loan. In many instances, PPP has driven cash balances unusually high; some companies are sitting on more cash than they’ve ever had.
But for valuation purposes, PPP money is typically a non-operating asset. It’s literally extra money, and by itself, it has no impact on future earnings projections. Still, companies can use PPP to enhance their value by investing it in growth and development through technology upgrades, expansions and bolstering their workforce.
Getting it Right
Whether you’re buying or selling, you want an accurate valuation that leaves no stone or contextual detail unturned.
At Sikich, we specialize in valuation consulting as part of our total package of transaction advisory services. Few, if any, firms our size offer financial and technology due diligence, tax consulting and assistance with deal structures all under one roof.
For valuations that are right on the money after a very unusual year, put Sikich on your team. Contact us to speak to one of our advisors today.