Corona Virus – Impact on Valuations, the M&A Market, and other Insights
In light of the unprecedented global impact of the Corona Virus, we have paused our series on business transition and instead want to highlight on a few key issues that business owners should consider during this uncertain time. There is nothing more important than our family, friends, and employees’ well-being so any items below are simply viewpoints from an advisor’s perspective and in no way meant to make light of current events.
Valuations / Risk – An Inverse Relationship
In its simplest terms, valuation is a function of two primary factors: economic benefit (i.e. profit, EBITDA, cash-flow) and risk of achieving those benefits. Most everyone understands that an increase in profitability of the business will have a corresponding increase in overall valuation. Risk, however, has an inverse relationship. Higher risk translates to a lower value, while lower risk translates to a higher value.
Business owners wake up every day with the reality that risk of any economic, industry, or governmental change could significantly alter their business and its value. However, as a general rule, Americans have had more stability and a business-friendly environment to operate in than other countries. So, the perceived risks mentioned above can seem minimal at times and for the last eleven years or so everything has been on the upswing. The “Great Recession” of 2007-2008 was a distant memory until the last month.
So, for most businesses, the expected cash flows may have diminished in the short-term along with the increased risk from the global circumstances. Thus, current valuations levels have most probably declined for most companies. However, assuming the economic engine can get started back again, this decrease may not be as severe depending upon the industry.
Leverage – Good, Bad, or Indifferent
During this period, the famous Warren Buffett quote comes to the forefront, “Only when the tide goes out do you discover who’s been swimming naked.” The apparent interpretation being that things may look good up to a certain point, but if a company is leveraged too much expecting a wave to come, but instead the tide goes out, everything will be exposed. Overall, our economy has been strong and reaching new heights and hopefully will recover quickly. However, this still reinforces the fact that the Company’s management should properly position the business with the proper amount of cash reserves and only rely on a moderate amount of debt as not to force the Company into bankruptcy when an economic slowdown does occur.
Opportunities – Making Lemon from Lemonade
So, during this period of economic slowdown (hopefully temporary), companies that were on the edge and overextended will be hit the most. However, for companies with a strong balance sheet and well capitalized, they will be able to whether the storm and come out the other side with significant opportunities. Their will likely be plenty of companies that are looking for an exit strategy in the M&A marketplace at lower valuations than before the crisis. Also, with the realization that some companies will not make it out of this downturn unscathed there may be less competition in the short-term.
From an operating perspective, companies that have the ability to deploy a remote/work from home option have found significant advantages with current technological advances that make it pretty seamless and help overcome prior prejudices. In our own business, the ability to have easily video conferences and stay connected with our team keeps everyone engaged and work moving along. Thus, it seems like more and more companies may integrate this into their business norm and reduce their physical footprint which could free up cash flow used for rent or overhead and focus on other growth strategies.
From a personal perspective, there probably is not a better time in more than a decade to transfer some significant ownership interest through an estate/gift strategy to the next generation if that is in your long-term plan.
Summary: In conclusion, again we want to reiterate our sincerest sympathies to anyone and everyone to whom this virus has impacted directly. Also, the indirect impact from the economic slowdown is having on all businesses, employees, and our community. We acknowledge that transaction work may slow in the short-term, however, we still will be here to be a resource once the economic engine does restart.
Transfers to Management Team / Key Employees
Transfers to Employees (ESOPs) – Overview
Transfers to Employees (ESOPs) – Technical Discussion
This article is simply a high-level overview of complex topics and does not constitute valuation, tax, or legal advice. Readers of this article should seek the services of skilled and experienced professionals.
Vision Point Capital focuses its services in three pillars of consulting for business owners: 1) Valuations; 2) M&A Advisory, & 3) ESOP Advisory. Working with business owners and their advisors is in our DNA. Please check out our website at www.visionpointcapital.com for more information about our services and team members.