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How the CARES Act and PPP loans impact business valuations

Mar 24, 2021

By Emily Britt

We’re all aware of the unprecedented impact the COVID-19 pandemic has had on businesses. Many businesses had to temporarily close, while others could only remain open at reduced operating levels. These restrictions limited cash flow and resulted in depressed valuations for affected organizations.

As we look forward to a recovering economy, let’s review how your business value may have been impacted by CARES Act assistance. Government relief programs are affecting valuations, and those changes can have big implications for M&A decisions, new equity partnerships, estate planning and couples going through a divorce.

What determines value and value considerations?

Business value is driven, in large part, by cash flow and risk. Valuation analysts are looking at the presence of predictable revenue streams and the likelihood that financial trends will continue.

Business valuations are forward looking and, in the aftermath of COVID-19, analysts will consider how macro and micro trends could affect your company. This will include a careful look at businesses whose revenues or supply chains were disrupted by the pandemic and those that could be hurt by an ongoing recession.

Risk is naturally heightened in times of economic uncertainty. The greater the risk, the less the value. That said, some businesses experienced “COVID windfalls,” which could translate to gains in valuation.

How might PPP loans affect value?

There are multiple approaches to valuing a business. The income approach applies the opportunity cost of capital to future benefit such as cash flow or net income. Analysts will need to consider how a company’s cash flows were impacted by CARES Act provisions and whether that cash flow is sustainable in the future.

The Paycheck Protection Program (PPP), for example, provided emergency relief funds so that businesses could continue meeting certain obligations such as payroll and lease payments. PPP provided cash flow to businesses, which may be treated as low-interest loans, or — if the business meets all the requirements — as a forgivable loan or grant. Valuation approaches need to account for any outstanding PPP loans, the interest rate and the probability those loans will be forgiven.

If the analyst determines the loan is part of the company’s long-term capital structure, they may use a Weighted Average Cost of Capital (WACC) to determine value. In doing so, the analyst will consider the long-term cost of debt at valuation date.

Likewise, temporary changes to tax laws created one-time surges in cash flow for some companies. Businesses could defer unemployment taxes or receive an employee retention credit. Some businesses amended tax returns and generated refunds using the temporary net operating loss carryback, and others generated refunds through the elimination of the cap on business losses on a personal returns.

Through a combination of strategies, including those above, businesses could free up a lot of cash flow in a very short timeframe. Valuation analysts will take a close look at where cash flow came during the pandemic.

If you do go back and amend your business returns to generate cash, it’s in a sense “artificial” cash flow. It’s good, healthy cash flow, but it wasn’t necessarily generated by the business, and it won’t likely be repeatable in the future — so it won’t necessarily maintain or enhance your value.

Other CARES Act implications

Beyond understanding where cash flow came from, valuation analysts need to understand why a company sought a PPP loan or took advantage of other CARES Act provisions. The analyst needs to determine whether acceptance of CARES Act funds indicates the business is under duress. If that’s the case, past positive results may not be indicative of future value.

Likewise, when valuing companies using the market approach, analysts need to account for whether comparable companies are also benefiting from CARES Act provisions, as this can impact financial metrics and valuation multiples.

How a business valuation impacts decision-making

It’s important to understand valuation changes and what they might mean for your business decisions going forward.

M&A activity: If you’re looking to buy a business, now may be an opportune time. There may be distressed opportunities on the market and sellers anxious to get out. Plus, interest rates are favorable, meaning this may be a good time to borrow money and grow through acquisition before conditions change.

If you’re looking to sell your business, and you’ve been negatively affected by COVID-19, you may want to wait until the market outlook is more predictable. On the other hand, demand remains strong for COVID-proof operations.

In terms of selling, consider potential tax changes ahead. The Biden tax plan proposed doubling capital gains taxes. That means business owners thinking of selling need to be just as concerned (if not more so) about the total they’ll net out after a sale as they are about their valuation.

Estate considerations: If you’ve been considering gifting or estate planning, now may be the right time to gift the most shares. If you’ve experienced a decline in value, this is a chance to gift equity at a lower value to minimize gift and estate taxes. For some, this means they can avoid assets within their lifetime exemption, avoiding what would have previously been a taxable event before the pandemic.

Some assets that have reduced value now, will grow again as the economy recovers. Be aware that the Biden tax plan, put forth during campaign time, proposed reducing the estate tax exemption by roughly 50%. Again, talk to your advisor about minimizing tax liabilities as part of succession and estate planning.

How Wipfli can help

Wipfli provides business valuations to help business owners make well-informed decisions about M&A, gifts, growth or partnerships. An up-to-date valuation can help you determine the next steps for your business and your family.

Once you understand what your business is worth, our CPAs and estate planners can help you understand current market conditions and tax liabilities. We can help you evaluate whether the time is right to sell, grow through acquisition or gift assets as part of a holistic estate planning strategy. Contact us to learn more.

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