Expectations of Value and Garages
During the last week of February 2020, public equity markets began their largest decline since the financial crisis of 2007-2008. By the time it had bottomed out nearly 30 days later, the S&P 500 lost about a third of its value. The question I often get asked these days is “how has this impacted my private company value?” I also get asked if I’m ever going to paint the garage. That one’s easier to answer: Maybe.
We generally don’t think of the value of private businesses as having the same volatility as publicly traded companies, but the fundamentals are the same for both. Value is, at its core, a function of earnings, risk and expected long-term growth. In the halcyon days of yore, we became comfortable with a simple multiple of EBITDA as that captured earnings (EBITDA) and the risk/growth (market multiple) as a fair proxy for value.
The current pandemic impacts all of these to varying degrees for both public and private companies. But even the companies that are seeing increased earnings (e.g. courier/delivery services or video-conferencing services) are facing changes to long-term growth and/or risk. Those with low perceived risk, say a gas station, are enduring much lower earnings. Restaurants have been hit by the triple whammy as earnings, risk and growth have all taken a hit. Except pizza joints. Those places are killing it right now.
In aggregate, it’s understandable that values may be down, but if so, by how much and for how long? We’ve already seen an increase in the S&P 500 to the point that it’s only down roughly 8% from its high in February. This is, in part, due to changing perceptions of risk and long-term growth. Historical data proves that there is almost no correlation between quarterly stock returns and real GDP growth in the same quarter. In other words, the market is predicting earnings, risk and growth in the future and, to an extent, ignoring the current/historical performance.
Similarly, if we’re looking at the current value of a private company, historic earnings are not as meaningful as forecasted earnings. But even if conditions are expected to return to “normal” in six to twelve months, any reduced cash flows in the interim period will have a negative impact on value. It would also be questionable to apply private market transaction multiples to current earnings, even those that are impacted by COVID, as the implied risk baked into the multiples for Q1 2020 don’t capture the change in risk.
This challenge of understanding current value is part of the reason private transactions have slowed considerably. The stay at home orders have also left their mark as there are no site visits.
But for every reason that selling a business is a challenge right now, it may be an excellent time for transferring interests as part of a larger estate planning process. Current estate tax rates and gifting exemptions may be targets for change to address the country’s mounting debt problem.
I’d welcome the opportunity to discuss how this may impact your business’ value. Feel free to call, e-mail or stop over to my house. Just be sure to wear old clothes and bring an extra brush.