The current pandemic has caused widespread disruption to the retail sector, with many struggling to maintain a healthy cashflow and revenues and profits down on previous years. Knowing the different types of valuation methods and when to use them can help business owners know what their company is worth now, helping to support their individual strategy.
While trends such as the rise of ecommerce and increase in High Street insolvencies have been evident for a number of years, they have been accelerated by the Covid-19 pandemic. Headlines such as John Lewis’ decision not to award its employees an annual bonus last year, for the first time since 1953, and the wave of retailers announcing restructuring plans, have emphasised the financial strain that many businesses are under.
In the current climate, many instances where a business valuation is required will be delayed or not go ahead. For the valuations that do go ahead, for example, implementing employee share schemes, management buy-outs, restructuring or even a sale, it’s unlikely to be a straightforward process. By understanding the range of valuation methods available and when to apply them, business owners can learn what their company is worth to support their plans on the road to recovery.
The main established techniques used for business valuations – discounted cash flow (DCF) or capitalisation of earnings – can be difficult to apply in an economic turndown and can result in a valuation which may not reflect what the business is actually worth. Despite these complications, it is still possible to value a business using these methods.
The DCF method reflects that the valuation of a business depends on its future net cash flows, reduced to recognise the risk of achieving those cashflows and the time span over which they are achieved. It relies upon the certainty and availability of detailed reliable forecasted cashflow figures, often several years into the future. Currently the ability to forecast is much more difficult, especially where there are foreign transactions, due to the volatility in exchange rates. A business could apply a number of scenarios or ‘what-if’ events to the forecasted cashflows to provide a range of values, as well as updating based on the current management accounts. This will help to provide the most accurate position possible.
The capitalisation of earnings method involves multiplying expected future maintainable earnings by the market multiples observed for comparable listed companies and/or in comparable transactions, allowing for adjustment for certain factors such as marketability and control. This therefore relies on a business’ key financial data, both historic and forecast. In the previous 18 months, many businesses will have experienced lower revenue and profits or even losses than in previous years. This can distort the current business value so as an alternative, especially if a business is expecting to recover to pre-pandemic levels, a business could look at previous profitable years and exclude the ‘outlier’ years.
This method also relies on obtaining a suitable multiple. As multiples are linked to market data, any fluctuation or volatility in the markets would then be reflected in the valuation. In the current climate, it is worth obtaining a multiple from several sources to ensure it is suitable. Retailers should also consider the net asset value of the business, which can provide a useful cross-check and will sometimes be the primary method if a business is loss making.
However, the current net asset position may not be reflective of the current values of the assets and liabilities. It is also essential to consider the realisable value of the assets. At this time, asset values may have fallen, so adjustments would be required to return the balance sheet to its current value. Other external valuers may also be required. For example, if the business owns property this would need a separate valuation.
While using these methods will provide a base valuation for the start of any negotiations, the current uncertainty means that it will not be 100% accurate. It is therefore essential that any business valuation uses the most appropriate method, taking into consideration the business’ current circumstances, the purpose for the valuation and the financial information that is available.
If retailers are considering selling up in the near future, there are a number of things they can do to improve their attractiveness to potential buyers. The three most important are:
- Improving the robustness of the business model, often by having multiple income streams, is critical. This has been highlighted in recent times by those retail businesses with a strong ecommerce platform as well as traditional high street presence.
- Having strong data sets, so that figures, trends and the impact of external events can be measured.
- Building a strong management team. Whilst not necessarily critical to all buyers, an experienced and effective management team that make good and sound decisions will provide resilience within a business and contribute to its robustness and value.
Retailers should also consider options such as employee share incentive schemes to boost employee retention and reward key individuals. These schemes can help to get people on board with the business’ commercial objectives, helping to drive up the overall value of the company.
With lockdown restrictions beginning to lift, many business owners across the retail sector are hoping for better trading conditions ahead. Ensuring they have an accurate business valuation is a useful tool to support their plans and facilitate any financial restructuring that might be necessary in the months ahead. By applying the right valuation technique and getting the right expert support, retailers can plan for a more profitable future, with the right structure, with confidence.
Georgina Davis (CTA) is a senior business valuations manager and part of the retail & wholesale sector team at accountancy firm, Menzies LLP.