By Colin McCrea
In today’s uncertain economic climate, business valuation has certainly changed. There are lower expectations for earnings, more risks at stake, and many other unknown complexities that your business is not prepared for.
In the event of an economic downturn, business valuations should be conducted in such a way that the best valuation results are obtained.
How does the economic downturn affect business valuation?
While most economic failures are caused by cultural factors, there are some factors that are difficult to predict. Business valuations can be affected by an economic downturn in two ways; It may reduce business revenue prospects, and there may be a more conservative business risk assessment that results in higher discounts and valuations.
Despite the economic downturn caused by Covid-19, there has been a significant increase in US venture capital investments. From 2020 to 2021, the investments almost doubled, resulting in a significant increase in the 2021 startup valuation.
However, despite the high inflows in venture capital investments, there has been a sharp increase in the forecast from 2021 to 2022. For example, as shown in the graph below, the value of the public software industry has declined over the past year.
According to venture capitalists, this increase in valuation multiples could be due to several factors. These include inflation, tensions in the geopolitical landscape, expected interest rate hikes and the seemingly never-ending COVID-19 pandemic.
Finding value
During a recession, the level of uncertainty surrounding business valuation can make this process difficult. Here are some tips to help you manage your business in a recession
1. Improve cash flow; Recessions inherently threaten cash flow, and in an effort to fuel growth and jobs, companies must work to improve cash flow and stabilize earnings.
2. Identify the risks you face: A business vulnerable to an unpredictable economic environment must prepare for the worst. A business valuation consultant must have a thorough understanding of the risks they face and their impact on the business.
3. Budget for Medium and Long Term Growth: For a business in a recession, the key to improving valuation may lie in long-term planning and annual budgeting. It is important to prepare a financial plan for the business and allocate funds for strategic initiatives at the appropriate time.
4. Marketing and Networking: Increased marketing and networking drives traffic to the business, thereby improving visibility and generating leads. In the event of an economic downturn, it is important to focus on the market and increase the level of exposure.
- Increase organic marketing and advertising spend: Advertising can be very expensive, and any additional costs will be scrutinized during an economic downturn. So, to make the most of your investment in marketing, it is better to increase your budget for organic marketing than advertising.
5. Don’t underestimate employees: Any negative things that are done to the employees during an economic downturn will have a negative impact on morale and productivity. The business valuation consultant should strive to maintain a positive environment during economic downturns.
Severe economic downturns and market downturns can have a significant impact on business valuations. The key to making sure you get the best results from a business appraisal is to develop a basic understanding of the industry and its economic climate.
Colin McCrea is a Certified Valuation Analyst with many years of experience conducting business valuations for clients in a wide range of industries (seed to Series C) and more traditional companies. He is currently with Eqvista.
Example: Dom Guzman.
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