Valuing a business in the Covid world

The immediate impact of the pandemic, and the measures taken to control it, have had well documented consequences across most, if not all, sectors of the economy. As government support is withdrawn it is unfortunately inevitable that unemployment will increase significantly, bringing very real human costs and downward pressure on consumer spending.

Looking forward it is nigh on impossible to predict how long the pandemic will last, how effective the public policy response will be and what steps the government will take to recoup the massive public debt racked supporting the beleaguered economy. Beyond the direct impacts of Covid-19 it is certain that living through the virus and numerous lockdowns will result in long term changes to consumer and business behaviour that will have far reaching effects across the economy.

Valuing a business in this environment is certainly a tricky task. However, it is a challenge that many are keen to take on. M&A activity is still happening. Since the pandemic started, we have sold two businesses and made one investment. Deals are still being completed by many other private equity and trade buyers and the IPO markets remain open to the right businesses – so there is liquidity out there.

It is important to remember that any business purchaser is most interested in the future. The value of a business to a potential acquiror is a function of the expected future profits, cashflows and strategic benefits to the acquirer’s organisation. The standard financial services disclaimer warns that “Past performance may not be indicative of future results”. Never has this been more true. This means that valuing a business today requires careful consideration of the impacts of the pandemic on both the current trading performance of the business and also its future prospects.

A starting point is to quantify all of the impacts on the reported trading of the business (both good and bad) and identify whether these are likely to be temporary (e.g., cancelled orders from customers expected to return) or permanent (e.g., products that may be rendered undesirable following the Covid-19 experience). The impact of state support (for instance the furlough scheme or grant support) should also be quantified. The point of this exercise is to arrive at a view of EBITDAC (Earnings Before Interest Depreciation and Covid) that gives a baseline estimate of how the target business (as currently constituted) would perform in the post Covid world. This EBITDAC calculation can then be “sense tested”.

The question of what multiple to apply to EBITDAC requires even more judgement. Starting from multiples used in recent M&A deals and of comparable quoted business, provides a starting point. It’s important to remember though, that these transactions will likely also involve “Covid Adjustments” invisible to all but those closest to the deal. After that it is about an assessment of the opportunities and risks facing the business as the economy emerges from Covid induced torpor, into a world that has changed in ways we don’t yet fully understand.

Another way to address uncertainty around post Covid trading prospects is around deals structure. “Earn-outs” where the price is in some part determined by the future profits, are likely to come back into vogue, alongside profit based “equity ratchets” – all methods to “true up” a valuation once more is known about the post Covid world.

While challenging and risky there will be rewards for buyers who get their valuations right (or at least not too wrong). The economy will return to growth at some point (the Spanish flu pandemic of 1919 was followed by the “roaring twenties”) and there will be opportunities for well positioned and managed business to flourish. Vendors wishing to sell need to be prepared to provide a detailed and justifiable analysis of the impact that Covid has had on their business; along with a vision of how and why it will flourish as the pandemic recedes.

We at Key continue to actively invest, seeking opportunities to back businesses and management teams with the vision and strategy to weather the current storm.