Forward-looking valuation of small businesses has always been a challenge. Few comparable transactions exist, in-house financial information may be scant, and projections are complicated for owners—even in the best of times.
The pandemic magnified these difficulties. But according to valuation analyst Gregory Caruso, JD, CPA, CVA, using a COVID-19 discount for lack of marketability (DLOM) may be the way to adjust for pandemic-related uncertainty and risk in small business valuations.
As Caruso explains, for some businesses, the pandemic increased the risk of future cash flows. In normal times, valuation analysts accommodate this risk by lowering the multiple in the market method or adjusting the company-specific risk in the capitalization of earnings method.
Caruso suggests another option: adding a specific COVID-19 marketability discount on control interests, saying “it clearly shows the valuator’s thought process and the actual discount being applied for the current high level of uncertainty.”
Before applying a COVID-19 DLOM, Caruso values the business as he would have pre-pandemic. He starts with restricted stock studies and then uses a weighting process to assess additional risk, including COVID-19-related matters specific to the business.
These matters might include excessive uncertainty about pandemic recovery, supply chain issues, shutdown orders, employee response to vaccination, and market issues. Government action, the emergence of COVID-19 variants, and confidence in the company’s product or service relative to recovery are also likely elements.
Of course, some companies are fully recovered. But many are still catching up—and some may not be recovering at all, which makes a COVID-19 DLOM worthy of consideration.
A high level of professional judgment is required in these types of valuations. Be sure you are working with experienced valuation analysts who can support their opinions.
Interested in discussing valuation discounts? We’re happy to share our knowledge. Contact a Hantzmon Wiebel team member today to help you determine your next right step.
Source: Business Valuation Update
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