The beginning to 2020 has been interesting so far. We went from the highest reported DOW Jones average in February, to a 30 percent drop in market value a month later. But what does that mean for values of privately held companies?
To answer that question, we must know three things:
- Investor expectations
- Cash flow expectations
- Growth expectations
Let’s begin with ‘investor expectations’, or the required rate of return to entice investment. Will COVID-19 change investor’s rates of return when they invest? Maybe, time will tell. I tend to believe as humans we adapt and change until ‘change’ is ‘normal’. All else being equal, if investors require a higher rate of return in the future, asset values will decrease.
Will COVID-19 change expected cash flow? Absolutely, over the short-term for most companies. Long-term cash flow impacts depend on the staying power of COVID-19 from season-to-season and even year-to-year. A decrease in cash flow will decrease asset values.
Will COVID-19 change long-term growth expectations? This is very difficult to assess because we, as appraisers, think of the long-term growth rate as a perpetuity growth rate. I think it is reasonable to decrease the long-term growth rate by 10 to 20 basis points currently. A decrease in the long-term growth decreases value.
So, all three impactful inputs to valuation presently indicate a decrease in value for privately-held companies. Time will tell what the new normal is for our economy, but remember, we overcame 2001 and 2008.
Michael R. Metzler, Director, CPA, ABV, CMA, CGMA, ASA