Our Job Is Much Tougher Now!

For purposes of this post, please ignore small buy-a-job businesses and large ones that can be valued using public comparables.  I am thinking about the typical business I, and most of us, usually value, a private operating company with sales of a few million dollars.

 Who knows what is going to happen macroeconomically: for example, will the federal stimulus plan be effective (when, and to what extent); what will this mean for inflation and interest rates; when will consumers resume spending and businesses resume investing; when will credit become widely available again…and so forth.  Moreover, what will this mean for specific industries and companies? Nobody can tell, and this creates enormous uncertainty (not risk, which can be measured with probabilities of defined outcomes).  This (duh!) drives business values down!

It also dilutes the effectiveness of many valuation methods.  We can’t use pre-crash private guidelines (or prior company transactions) and there are very few current ones.  Bye-bye, market approach.  Under the income approach, financial forecasts and projected benefits are hugely uncertain, and, as we know, historically-based estimates of discount rates are also off the mark.  Under a going concern premise, the asset approach relies on the same financial forecasts and discount rates, so it is highly uncertain.  Under a liquidation premise, there are also increased uncertainties about fixed asset and intangible values.

This state of affairs – limited data and methods with high uncertainty – is going to last until we either accumulate sufficient data or the macro uncertainties are reduced.  That could be a long time from now!

This implies that:

Actual transactions will involve more earn outs and other risk-sharing arrangements between buyers and sellers.

1. Contemporaneous fair market valuations will trump retrospective ones, as they always should.  See Revenue Ruling 59-60, Section 3.03.
2. Fair value appraisals for financial reporting (considering typical market participants) will require great care in reconciling market- and income-based results.
3. Litigation is going to get really bitter. Regardless of statutes specifying the valuation date and degree to which hindsight is excluded, you know that this is going to come up. In jurisdictions in which equitable value (whatever that is) is the value standard, this could be a major nightmare.

Above all, be humble. The current uncertainties mean that the reasonable range of business values is much wider than it was a year ago.  Reasonable, competent, honest and objective men and women, given the same information, will be able to arrive at legitimately vastly different value conclusions.  Because we have to usually pick a single point in that wide range, we are going to be in the cross-hairs of those who oppose us.