According to Business Valuation, “value” is determined at a specific point in time. It is a function of facts known and expectations made only at that point in time – and what a time it is.

Under normal market conditions, businesses are constantly in a state of flux because of changes in product lines, management, financing arrangements, market conditions, general and business-specific conditions, industry and competitive conditions, and other factors. We now have the COVID pandemic, which has turned everyone’s lives upside down.

The COVID-19 pandemic has caused an economic and social retraction unseen in a century. The significant toll the pandemic has caused the global population and economies is unparalleled, creating significant uncertainty and anxiety around the globe. Many businesses have been shut down, and many are unsure what the future holds or how the pandemic will impact them. Conversely, many businesses in key industries have experienced a “COVID bump”, which is causing record performance. The construction and renovation industries, in some part, have participated in this increased business activity.

Our clients have asked us if we have changed our approach to valuing companies in the construction and renovation industries. In some cases, we have, given the higher levels of uncertainty; however, we traditionally valued companies based on the fundamentals of expected future after-tax cash flow, and that has not changed.

Traditionally, we would evaluate some of the following in our valuation of companies in this industry:

• Historical performance versus projected performance – Is there a demonstrated and repeatable business model that has been working and will continue to work? Can management execute consistently?

• Backlog and sales pipeline – Is there a healthy pipeline/backlog of projects that will increase the probability that forecasted growth will be achieved?

• Market conditions – Are market conditions conducive to continuing growth and is the company’s supply chain healthy and trade pool available to achieve market success?

• Cash flow – Does the company manage cash well and optimize its cash to weather changes in market conditions? Does it have sufficient cash balances to ensure operating efficiency and compliance with lender requirements?

• Cash accounting vs. accrual accounting (and revenue recognition methods) – Which does the company employ and how much risk does that create in the company’s cash flow cycle?

• Return on assets and goodwill creation – Does the company consistently generate a return on its assets and create goodwill in the marketplace?

In the world with COVID, much of the above still holds; however, we are required to consider some new realities:

• Higher uncertainty and sustainability of cash flows – Given the higher level of uncertainty in the marketplace, how far into the future should we be evaluating cash flow? Do we need to shorten our horizon and focus our analysis on more near-term effects?

• Sustainability of business volume – Will business volumes continue at higher levels in the future? Will there be a downward adjustment in business activity in the near future?

• Capacity – Is the company working at peak capacity? Is there a labour/trade shortage that may impact the quality of projects and/or the company’s ability to continue to meet demand? Can this level of activity be sustained?

• Employee absenteeism and lower employee productivity – Are more employees missing work due to COVID or are they struggling with productivity to manage children or other family commitments?

• Supply chain – Is the company’s supply chain at risk due to COVID?

• Government spending – If a company’s revenues are tied to government spending (municipal, provincial, federal), will government spending retract soon due to record budgetary deficits? When will the subsidies end?

• Excess cash – Is there such thing anymore? Will companies need to “hoard” more cash to protect themselves from future downturns?

• Discount rate volatility – Increased market volatility have (and will have) a material effect on discount rates. This may cause downward pressure on company valuations in the future (all else being equal).

Business valuation has always been “part art, part science”, which has never been truer than today. The level of market uncertainty, coupled with the lack of data and understanding how our worlds will change from one day to the next, cannot be underestimated. Business valuators must be prepared to address all these realities and provide these insights in a careful and considerate way to their clients.

This article was written by Adam Nihmey, CFA, CBV, Managing Director of Valuation and Litigation Support, at Welch Capital Partners Inc. in Ottawa.