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Valuation of Distressed Businesses and Real Property in the COVID-19 Crisis

Posted by BEACo on May 28, 2020

The Fair Market Value of many businesses and real properties have been detrimentally affected by the Coronaviris pandemic. This article describes and addresses significant points in the business valuation and appraisal process.

An appraiser reviews the recent and present earnings of a business and/or real property and prepares a forecast of future operations.  The prospect of forecasted income is a driving force, a compelling motivating factor for a buyer.

IRS Revenue Ruling 59-60, enacted years ago, remains applicable today.  The Ruling outlines the steps to take into account when valuing closely-held businesses.  It states:

The Fair Market Value of businesses will vary as general economic conditions change from "normal" to "depression".

The change is reflected by the degree of optimism or pessimism of the investing public, as it regards the future of the business at the date of appraisal.

This premise holds true when valuing a business for litigation or non-litigation matters.

Uncertainty as to the stability or continuity of future income "decreases"the value of a business and real property, by increasing the risk of lost earnings.  The value of stock in a company with very uncertain future prospects is "highly speculative".

Valuations may be looked at as being "prophecy" as to the future, to be based on the facts available at the date of appraisal.

The appraiser starts with the Fair Market Value of the business before the virus, as of (say) "normal times".  The Seller wants this done - "Look, this is the value I built-up, and it will be its value when this is over."  The prospective Buyer wants a guide as to its future value, but will probably have a different take on it.

What is the date of value?  As of what date is the appraiser to "zero in on"?

The selection of the valuation date is determined by legal counsel, and not the appraiser.

Some businesses have suffered greater losses than others.  They include food markets, drug stores, restaurants, dry cleaners, to name a few.  Looking at the broader picture, loss of values include many entities in manufacturing, distributing, retailing and the service industries.
Let's take as the example a seafood processing and distribution business, to be valued as of April 30, 2020 in a litigated matter.  Prior to the pandemic, its restaurant customer base was expanding and its ongoing operations resulted in increasing income and value.
In determining the value of the business and the cost to keep it limping along until it recovers, the appraiser prepares an accrual basis balance sheet at the date of valuation.  In this way, the assets and available working capital are calculated.  An income and expense forecast will determine the drain on those resources, and whether outside funds will be required during the "back to normal" period.
The appraiser estimated the Fair Market Value of the business to be $5,000,000, both at the date of value and in the future, when the business and the economy are back to normal.
At the current date of appraisal, however, the entity had lost 95% of its restaurant business, and all of its banquet hall clients.  It had been compelled to lay off its full-time processing line employees, curtail its rent payments, etc. -- to cut its expenses.
The appraiser estimated that between the current appraisal date and its recovery, it would cost the owner/seller $2,000,000 to keep it running.
So is the business worth $3,000,000?  The $5,000,000 value in the future less the $2,000,000 expense?  Probably not.
The prospective purchaser feels that the $5,000,000 may not represent the future value of the business, and also suspects that it may take more than $2,000,000 in net expense during the interim period.

The Buyer asks: "From whom will I borrow the additional funds and how long will I have to pay it back?"  Working capital loans are currently difficult to negotiate.

The Seller says: "If I don't get a reasonable offer, I won't sell.  I can run it myself and build my business back up.  I did it before and I can do it again."
The business valuation process for a distressed entity is similar to the one applied to a contaminated real property.  The Fair Market Value of the property as though uncontaminated minus the estimated cost to cure begins the appraisal process.  Of course, the value in the after-condition may change, as may the $2,000,000 cost to cure estimate.  Both the Buyer and the Seller understand this.
The valuation methodology outlined above also applies to the appraisals of businesses for  purposes other than litigation -- estate planning and estate taxes as an example.
Determining the Market Value of real properties whose current values have also been affected requires a current prepared income approach.  Today's market comparison approach would identify sales that took place "before" the pandemic, and therefore would not represent the detrimental effect on value.  It's too soon to employ the comparison approach.
Furthermore, real property brokers have reported that earlier pending transactions were either delayed or have fallen through.
We are in a time of speculation and uncertainty -- with our economy, our livelihood and our health.
Stay safe.
Larry Grant, President
Business Enterprise Appraisal Company, Inc.

Contact Business Enterprise Appraisal Company at: 818.591.9282