Business valuation impacts and estate and gift planning opportunities in the current economic downturn

We are in unprecedented times. The COVID-19 pandemic’s impact on our society and on businesses around the globe has been rapid, severe and complex. The ultimate duration and depth of the current economic downturn is unknowable, casting uncertainty across the U.S. and global economy and depressing valuations across most industries.

Though each business will be impacted differently by the current economic downturn, it is certain that the valuations of small- to mid-sized closely held businesses in particular—which generally lack the capitalization, diversification, and general resources of large public companies—have been quite significantly affected. As valuation and transaction advisors to thousands of businesses, we are seeing this firsthand. Other factors such as lack of availability of debt and private equity investors moving to the sidelines will also place downward pressure on valuations.

In such an environment, now may be an optimal time to pursue certain estate planning strategies that will provide for the future financial well-being of loved ones. In other words, now may be the time to effectuate wealth transfer strategies that will minimize tax implications and protect the passage to family members of financial assets, ownership interests in closely held operating companies and real estate and investment securities holding entities, and other property. Also considering that the Estate & Gift Lifetime and GST exemptions are $11,580,000 per person, for some families there may never be a better time to pursue these opportunities.

The following provides a summary of how the current economic downturn is impacting the valuation of closely held businesses.

Income approach

The income approach is fundamental to any valuation analysis. Typically taking the form of the “Discounted Cash Flow Method,” under the income approach, value is determined based on a projection of the future financial performance of a business, discounted to present value using a “discount rate” estimated to reflect the rate of return investors would require to compensate for the level of risk inherent in the business.

In the current environment, projection modelling — which is a challenging task in any time—has taken on an added layer of complexity. Because we are in such unprecedented times, it is difficult to use historical financial and operating trends as reliable indicators of future performance. The impact of the economic downturn will certainly have a negative impact on the forecasts of nearly all companies. However, careful support for projections is always critical. Key inputs and assumptions must be logically and adequately supported to withstand scrutiny and include both top-down analysis (macroeconomic factors, aggregate customer demand, competitive landscape, etc.) and bottom-up analysis (volume and pricing, cost of inputs/direct labor, overhead, operating metrics, etc.).