Impact of the Coronavirus on The Valuation of Small Businesses
The coronavirus pandemic is wreaking havoc on the global economy as we’ve seen last week with the stock market crash that compares to what we saw in 2008 during the financial crisis. Many businesses, big and small have lost an incredible amount of money last week alone. And may still lose more the coming weeks if the spread of the virus is not contained quickly.
According to the New York Times:
“Goldman Sachs economists expect global growth to slump to around 2 percent for the full year, down from their previous 3 percent forecast, but said in a note Friday that there are risks of a worldwide recession if the virus becomes a more severe global pandemic.”
So what will be the impact of this virus on the valuation of small businesses?
To answer this question we need to understand that valuation is based on three main factors: cash flow, growth, and risks. Assuming that growth is stable, the Gordon Growth Model calculates value as: Present Value = Cash Flow x (1+growth)/ (Discount Rate - growth).
So let’s analyze the impact of this coronavirus on small businesses through these three value drivers.
Impact Of The Corona Virus On Cash Flow
The cash flow of a company depends on its net income or profit. The net income depends on revenues generated by the company minus its expenses. When the revenues are reduced due to clients’ fear of virus contamination, the impact is immediate on your profit or net income. You will see a reduction in your profit, which in turn will reduce your cash flow. This cash flow reduction will adversely affect the value of your company.
Impact of the Corona Virus on company’s Projected Growth
The valuation of a company takes into account the projected growth of the company for the foreseeable future. This is important for investors as they seek to understand the long-term viability of the company they are looking to invest their money into. When a pandemic like the coronavirus is taken into account, it's hard not to lower the industry and the national economic perspectives on growth in the short-term (less than a year), medium-term (1 to 3 years) and long-term (4 to 5+ years). Therefore, the revised industry and national economic growth projections will have an immediate negative impact on any company’s growth forecast.
Because of that lower growth forecast, the company becomes less attractive to investors as the uncertainties mount over time. This has an impact on the value of the company.
Impact Of The Corona Virus On The Risks Of The Company
There are environmental or external risks as well as operational or internal risks in any company. They constitute together all the risks associated with doing business. The environmental or external risks are all these risks a company cannot control but that has an impact on the well-being of a company. They are mostly risks associated with the type of industry as well as the national, regional, or local economy.
When the economy is not doing well due to the impact of the coronavirus or when the industry in which the company operates is considered a high-risk industry, that has an impact on the value of the company as it is considered high risk for investors. The same is true when operational or internal risks are deemed high by investors due for example to the fact that a company has very few clients (no diversification), one key person running the company (no cross-trained employees), poor customers and/or employees satisfaction, low-profit margins, etc.
The valuation of small businesses will be lower to significantly lower if the virus continues to grow as projected by World Health Organization experts. It is hard to predict the real impact of the coronavirus on the national, regional or local economy at this point, but we are certain that if the disease continues to expand, that could install fear in communities, customers, employees and other stakeholders involved in a company’s well being.
The impact on small businesses could be catastrophic in the medium or long term. We see this happening in China already where businesses only have 2 months' worth of cash reserves to use in case of emergencies. After that, they will start closing doors and laying off employees. At that point, the company has no value what so ever.