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The BEACo Brief - October 2020

Posted by BEACo on October 18, 2020

This month, we'll discuss business valuations prepared for estate planning and estate taxes, now within the COVID-19 pandemic era.  While many distressed  businesses will recover if they are able to "hang on", others will fail.  Let'' center our discussion on those businesses we forecast that will ride it out, not those that will fail and not those that are currently doing better than before.
IRS Ruling 59-60 states in part that the FMV of businesses will vary as general economic conditions change from "normal" to "depression", according to the optimism or pessimism of the investing public, as to the future outlook of the business.  Uncertainty as to the stability or continuity of the entity's future income decreases its value, by increasing the risk of lost or lower earnings.  Uncertain future prospects increases the speculative nature of an investment and decreases its value.
Business valuations are a "prophecy" as to the future, and that value must be based on the facts available at the date of appraisal.  When the facts are unclear, fair and reasonable estimates and assumptions take their place.
The formula or steps to be taken to estimate the current Fair Market Value of the enduring business follows:
  1. The FMV of the business prior to the pandemic is determined. 
  2. The time period between the current date of value and the "recovery" or re-establishment of the business in the future is estimated. 
  3. The economic level at which the business is forecasted to operate when it has recovered is also estimated.  (Example:  75% of earnings?, full recovery at 100%?) 
  4. The revenue that the business is forecasted to generate between the date of value and the date of recovery is calculated as an offset against estimated ongoing expenses that will accrue during that period. 
  5. The working capital required during this period is established, along with its source, its cost and the risks associated with obtaining credit. 
  6. The last step is estimating the FMV of the business after it has recovered and is again operating as an ongoing and viable entity.
Summarizing:  The entity's estimated value in the future less the net expense of getting there represents the FMV of the business at the date of appraisal.
This is the same approach that a business owner would apply to determine whether to sell the entity now at a reduced price, or continue to invest in the business until a certain measure of value is again established.
Next month, we'll present the valuation of a business as of a current date by applying our formula.
Earlier editions of the BEACO Brief are available on our website.

Contact Business Enterprise Appraisal Company at: 818.591.9282