Today’s uncertain economic climate has certainly changed the valuation of businesses. There are lower expectations for returns, more risks at stake, and many other unknown complexities that may not be ready for your business.
In the event of an economic downturn, business valuations should be conducted in a manner that yields optimal valuation results.
How will a recession affect corporate value?
Most recessions are caused by traditional factors, but there are also some that are difficult to predict. Business valuations can be affected by economic downturns in two ways. It could lower business earnings expectations and lead to more conservative business risk assessments, which could lead to higher discount rates and cap rates.
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Despite the COVID-19-induced recession, U.S. venture capital investment has increased significantly. From 2020 to his 2021, investments nearly doubled, and 2021 startup valuations rose significantly.
However, valuations declined in 2021-2022 despite a significant influx of venture capital investment. For example, valuation multiples for the public software industry have declined over the past year, as shown in the chart below.
Venture capitalists say this decline in valuation multiples could be due to several factors. These include inflation, tensions on the geopolitical scene, expected rate hikes, and what appears to be a never-ending COVID-19 pandemic.
During recessions, the level of uncertainty surrounding corporate valuations can make this process difficult. Here are some tips to help you value your business during a recession.
1. Improved cash flow: An economic downturn naturally poses a threat to cash flow. Businesses must work to improve cash flow and maintain stable earnings to drive growth and operations.
2. Identify the risks you face. Vulnerable to a potentially unpredictable economic environment, businesses must prepare for worst-case scenarios. A business valuation consultant should have a thorough understanding of the risks you face and the level of impact on your business.
3. Budget for medium- to long-term growth: For companies in economic downturn, long-term planning and annual budgets may be the key to improving valuations. Creating a financial plan for your business and allocating funds to strategic initiatives at the right time is critical.
4. Enhanced marketing and networking: Increased marketing and networking drives traffic to your business, thereby increasing its visibility and generating leads. Focusing on marketing and increasing exposure levels is critical in a recession scenario.
- Increased organic marketing and advertising spend: Advertising can cost a lot, and additional costs will be scrutinized during an economic downturn. So, to get the most out of your marketing investment, it’s best to increase your budget for organic his marketing instead of advertising.
5. Don’t demotivate your employees: During recessions, negative emotions directed at employees can have a negative impact on morale and productivity. Business valuation consultants must strive to maintain a positive environment during economic downturns.
Dramatic economic downturns and market declines can have a significant impact on company valuations. The key to ensuring the best results from your business assessment is establishing a basic understanding of your industry and economic climate.
Colin McCrea is a Certified Valuation Analyst with years of experience conducting business valuations for clients in many industries, both funded companies (seed to Series C) and more traditional companies. He is currently affiliated with Ecvista.
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