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Selling in the Covid Era

A late April 2020 survey of over 300 small to lower-middle-market US-based companies shows one-third of respondents with Covid-impacted revenue being flat or up as compared with same period for 2019. Companies that have maintained or grown their historical revenue and profit during the Covid lockdown will be considered “pandemic-proof” and their valuations will reflect this economic resiliency.

The remainder of this narrative targets the two-thirds of companies that have been negatively impacted by the Covid lockdown and their owners who ponder an eventual sale liquidity event.

The process of selling a business typically takes 6-9 months. This gives buyers the ability to watch the for-sale company’s financial performance over time. If a company’s budget accurately predicts actual results in the ensuing months then that instills confidence in the budget and its ability to predict the future. Businesses able to map then execute a course of action will be more attractive, and salable, than their peers.

Given the steep economic drop since March, the marketplace for the remainder of 2020 and into 2021 is expected to emphasize current monthly financial results as they compare to future forecasts and prior years. We expect the highest valuations for those impacted firms that show a demonstrated upward trajectory in monthly revenue and profit.

The M&A industry is dependent upon bank lending. Part of the M&A loan underwriting process is to obtain a business appraisal. If the business does not appraise for the sale price then the transaction probably won’t close at that sale price. Therefore, it is critically important to understand how the appraiser concludes a business value, how it may be impacted by Covid and whether an Owner can supply information that can help the appraiser reach an objective conclusion.

The business appraiser’s job is to determine a company’s value at a particular point in time. The business appraiser uses two primary methods to determine value. The first is comparable transactions and the second is DCF (Discounted Cash Flow).

Business appraisers consider Covid-19 to be “an event”, an economic shock that fundamentally changes the future functioning of society and industry. Comparable sale transactions that closed during the Covid lockdown or later are virtually non-existent in spring 2020 and for most industries will be non-existent for months. Appraisers will continue to use pre-Covid sale transactions but, given the dearth of more recent comparable transactions, appraisers are expected to rely even more heavily on the DCF method to estimate a company’s value.

The DCF method of valuation uses a forecast (a budget) based on a company’s P&L and balance sheet. If a company’s historical monthly results are reasonably close to the previously-estimated budget then that adds credibility and increases the likelihood that the appraiser will consider using the company’s budget figures (and underlying assumptions) in their DCF calculation.

For the remainder of 2020 and 2021 valuation is expected to be based on a company’s ability to rise out of the Covid decline and back to “normal”. Back to normal means either 1) achieving same or better financial results as the years 2018-2019, or 2) a new-normal with changed revenue and profit. This is the business appraiser’s most important role: that of answering (1) and (2) and then assigning dollars to the future by creating a Discounted Cash Flow DCF model.

A business with a credible monthly budget forecast can supply this to the appraisal firm, who is then free to use it as input to create their discounted cash flow model for the business. A credible budget can positively influence the DCF’s numerator as well as its denominator.

Selling businesses in the Covid era will continue but with more valuation ambiguity surrounding those companies negatively impacted. To achieve a liquidity event for a given sale price those companies must budget the path to a new normal then validate with actual results. Those Owners able to accurately budget the future then prove with actual results will gain credibility with buyers, lenders and their appraisal firms.

The topic of this narrative is how to sell a Covid-impacted lower-middle market business for an acceptable price in the shortest amount of time. Those businesses that will sell most quickly will be those that demonstrate actual monthly growth combined with a plan that reasonably predicts growth over the ensuing 6-9 months then achieves that over time.

Dan Mulvaney, M&A Advisor

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