Has COVID affected business value?

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Looking to buy, sell or invest in a business? You may have to weigh many more factors during the current COVID-19 pandemic. And irrespective of whether you are on the buy side or the sell side, understanding the effect of COVID is important.

 

Hayes Knight chairman Greg Hayes said anyone thinking of investing in an SME should look at a range external and internal factors related to the business.

 

''You have to do additional work to determine what is the true fair value of a business now, '' said Mr Hayes. ''The total environment has to be considered, including the economy, the business itself and the industry it is in.''

 

In the past, anyone looking to buy or sell a business would likely analyse the past three years trading figures to assist in arriving at the value of an SME. But Mr Hayes noted that historical analysis may no longer present as accurate a picture

 

For example, a printing business may have been performing solidly over many years – consistent revenue and profit growth. And whilst there was a downturn over the early months of COVID, there seems to be reasonable prospects of the business returning to normal. However, a deeper investigation of its customer base uncovers that it has a large number of customers in the live entertainment sector, which has been one of the hardest hit by the pandemic. This business will not return to pre COVID operating levels until restrictions are lifted or alternately it secures an alternate customer base. Value may have shifted.

 

Almost all SME businesses are valued by one of two methods. One is the industry approach, which attempts to model the market. The value of a business is determined by reference to recent sales of similar businesses. Pharmacies, newsagents, real estate agents, coffee shops and professional services firms, to name a few often use this method. This method tends to be reliable in stable and active markets.

 

But these are abnormal times. Mr Hayes said the constancy and consistency required for the industry method was not there at the moment. The market for business sales has been less active in many sectors and updated information is yet to flow through into the broader market.

 

The other typical method of valuing a business is based on its maintainable earnings with a risk multiple applied to that figure. Some businesses may have had a valuation of four times earnings for example. But as risk increases, the multiple applied to a business falls, meaning it could be worth less. Understanding the risk profile of a business is important and different businesses will have different risk profiles.

 

Many SMEs are probably valued less than they were, due to the pandemic. This is an outcome of the increased risk environment. It may be a short-term effect, or longer term if there has been a material impact on the business.

 

For those businesses which seem to have performed well during COVID-19, you need to assess whether the increased activity was a short-term spike or actual systemic change. There will be businesses that out-perform in the current environment. In assessing value, the focus needs to be more on the present and the future, rather than simply the past.

 

Unlike the ASX, there is no index to indicate the value of private businesses. The pandemic has added greater complexity to the valuation process, meaning buyers and sellers should work even more closely with their advisers before making a decision. Ensuring you have the right information to support the transaction decision is essential.

 

Hayes Knight has experts who can assist on either side of a buy or sell transaction.

 

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