Private companies, whether you’re looking to value your business in preparation for a sale, to help raise debt or equity funding, for some other business purpose, or simply for your own edification, you’ve probably found that the valuation process isn’t an exact science and is rather intimidating.
This post focuses on a private company valuation approach intended to help you secure debt funding in the face of the COVID-19 pandemic, to drive home the point that now’s the time, private companies, to get ready for a more challenging credit environment. You’ve had a hard enough time getting the capital that you need to drive your business during “normal” times. With the economic destruction that we’re witnessing at the hands of the pandemic, that uphill battle is becoming even more steep. Regardless of where you fall on the credit spectrum, take stock of your capital needs and figure out how best to meet them.
Measure the value of your company to help secure debt funding with greater ease
Private companies, operating a business is risky, and though you may have every intention of achieving your business value projections, there’s no guarantee that’ll happen. With that said, your business valuation must reflect that uncertainty, particularly in your estimate of your discount rate. Simply put, the higher the discount rate, the greater the risk associated with achieving your value projections, which amounts to a decreased valuation.
Here are a few steps to help you think through the process:
Current/future state analysis. As your first step in the private company valuation process, consider analyzing current and anticipated economic and industry conditions. Many of you may not have expected the pandemic to carry on for this long and may even think that recovery is around the corner. While there’s no harm in hoping for the best, it’s critical that you plan for the worst, and when doing so, it may be helpful to reflect on several key factors, including the expected duration of the economic downturn and the expected recovery time, to name a couple. Remember, those of you whose response plans position you for growth beyond the pandemic are likely to be better qualified to weather the storm and adjust to the new normal.
Financial statement presentation. Financial statements are the next step in trying to put a number on your worth. As you prepare your financial projections ahead of submitting your loan application package or investor presentation, you want to avoid gaps that require explanation, as they tend to suggest weaknesses in your business. So, when preparing projected statements that cover periods including the effects of the pandemic, it’s important to highlight that actual amounts will differ from projected amounts and that the difference may be material, and explain how the impact of the pandemic on your financial condition is a contributing factor. For example, you’ll want to identify and discuss in ample detail the assumptions underlying your financials that are believed by management to be key, such as an assumption that your business will continue to operate for the foreseeable future. You’ll also want to consider whether the pandemic will constitute a force majeure event or another legal basis for nonperformance under your commercial contracts and, if so, be ready to evaluate the proper allocation of risks and consequences of further business decline on account of domestic and foreign companies in the supply chain not being able to perform as agreed or the other party to your contract being unable to satisfy its contractual obligations. These are just some of the considerations to be mindful of when projecting financial statement amounts, particularly while in the throes of the pandemic and its aftermath, when the potential for discrepancies is multiplied.
Voluntary disclosures. When submitting financials as part of your loan package, consider accompanying them with voluntary disclosures similar to the ones that public companies provide about non-GAAP financial measures, and in the MD&A and risk factor sections of their SEC filings. Doing so could eliminate some, if not all, of the “information risk premium,” the risk that managers are privy to information about a company that is unknown to a potential lender but that if known could impact that lender’s decision. So naturally, injecting some transparency into the private company valuation process can go a long way towards helping potential lenders reach a comfort level with you and your business. This, of course, means no cherry-picking information—disclose both the favorable and the unfavorable. The benefits can be enormous, from lower interest rates to a relaxation of collateral, covenant and other requirements (see also Reporting non-GAAP financial measures against the backdrop of COVID-19).
Peer group disclosures. Before crafting these voluntary disclosures, you may find it useful to review disclosures of similarly-sized public companies that are in the same industry and in a similar line of business as a benchmark (check out SECPlus Advanced on Thomson Reuters Checkpoint for filing excerpts).
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