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VALUATION IMPACTS IN A PANDEMIC

Posted by Phil Trem on May 5, 2020

FAQs on fair market valuations

MarshBerry has performed thousands of fair market valuations (“FMV”) for firms that are transacting stock internally, estate planning, buy/sell agreement requirements, general value curiosity, and a number of other purposes.  It’s important to note that the FMV of a business follows a specific IRS accepted definition of a hypothetical transaction and is not a strategic value that may be realized in the open marketplace.  Below are some frequently asked questions you may have if you are in the process of considering or are having an FMV performed on your business.

Will COVID-19 affect my firm’s fair market valuation?

There is no simple answer to this question, but the bottom line is probably yes. It largely depends upon the valuation “effective date” or the date through which we are evaluating the performance of the business (i.e. 12/31/19 or 4/30/20). FMV is derived as of a point in time and the valuation expert must place themselves on that date and consider impacts to the company that were known or knowable at the time. For example, if you were having a valuation performed as of 12/31/19, it would be knowable if the firm was going to close on an acquisition 1/1/20 because that likely would have been in the works for months and closing was near certain at 12/31/19.  However, it was unknown that there was a looming pandemic that would throw the stock market into a tailspin 8-10 weeks later and wreak havoc on the global economy.  Likely, any valuation date before February or March 2020 would not consider the current economic climate. 

How would my FMV be impacted with a later effective date?

An FMV can be performed using a variety of valuation approaches and methodologies.  The most commonly used are income and market approaches. 

1. Income Approach: An example here is the discounted cash flows method, which considers the future cash flows of a business at present value. Understanding the impact of the domestic shutdowns on insureds’ ability to stay in business and pay premiums, shrinking exposure base from headcount/payroll reductions, along with other factors are important to accurately forecasting the future cash flows of the business. A lower growth projection for revenue, or a reduction in projected profitability, would likely drive lower value.  Additionally, there is an assessment of a firm’s risk profile that is applied as a factor to the Weighted Average Cost of Capital to assess present value.  A firm that has higher exposure to industries that have been particularly impacted by the shutdowns may merit a higher risk premium in this case.

2. Market Approach: This is based on the principles of competition driving the market to equilibrium prices for assets, which can then be applied to the subject firm. Two common methodologies include looking at the trading values of publicly traded firms and the transaction values in private merger & acquisition (“M&A”) transactions. Year-to-date we are seeing that most public broker stocks are down anywhere between 9-16%. This decline in public company value would impact the subject firm’s value when applied as a proxy. Additionally, private M&A values (should they decline) would appear in this comparable methodology. It is still too early to quantify this potential impact as transaction activity has somewhat slowed in the current climate.  

What if my company has an Employee Stock Ownership Plan (“ESOP”)?

ESOP valuations are often more complicated, less flexible and are dictated by the ESOP benefit plan documents (including valuation date).   ESOP administration and transactions then occur at the value determined as of that date.  While others exploring FMVs may be able to delay the valuation to a later date that would include consideration of the pandemic, ESOPs may not have that option.  Some ESOPs may have the ability to delay payments or declare the need for an interim or mid-year valuation.  These measures should be outlined in the ESOP plan document.  See our recent letter to ESOP valuation clients here for more information.

Overall, the valuation impacts from COVID-19 are complex, multi-faceted, and will depend upon the agency’s specific situation and business drivers, as well as the valuation date. It will likely be a number of weeks and months or even years until the full impact on agency valuation is known.

If you have questions about Today’s ViewPoint, or would like to learn more about understanding the value of your firm, please email or call Phil Trem, President - Financial Advisory at 440.392.6547.

As we keep our eye firmly focused on the industry and actions within it, we are eager to know what you are experiencing. Take a quick 3-minute MarshBerry Pulse survey to help us gauge the industry’s response and outlook as the country moves towards “open for business” from the anticipated loosening of stay-at-home orders.

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Topics: Financial Advisory, insurance, economy, sba, value

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