By Colin McCrea
With today’s uncertain economic climate, a company’s valuation has definitely changed. There are lower revenue expectations, higher risks, and many other unknown complexities that your business may not be prepared for.
If an economic downturn occurs, company valuations must be carried out in such a way that the best possible valuation results are achieved.
How does an economic downturn affect company valuations?
While most economic downturns are due to traditional factors, there are some factors that are difficult to predict. Business valuations can be affected by an economic downturn in two ways; it may lower the expectation of business returns; and there might be a more conservative assessment of business risk, which may result in higher discount and cap rates.
Despite the economic downturn triggered by COVID-19, there has been a sharp surge in US venture capital investments. Investments almost doubled from 2020 to 2021, leading to a big jump in startup valuations in 2021.
However, despite the large inflow of venture capital investment, there was a valuation slump in 2021-2022. For example, the public software industry’s valuation multiples declined over the past year, as shown in the chart below:
According to venture capitalists, this drop in valuation multiples could be due to several factors. These include inflation, tensions in the geopolitical scene, expected rate hikes and a seemingly never-ending COVID-19 pandemic.
get value
In economic downturns, the uncertainty surrounding company valuations can complicate this process. Here are some tips to help you evaluate a business in an economic downturn:
1. Improve Cash Flow: Of course, economic downturns pose a threat to cash flow, and in an effort to fuel growth and operations, companies should work to improve cash flow and generate stable earnings.
2. Identify what risks you face: A company faced with a potentially unpredictable economic environment needs to be prepared for the worst-case scenario. The business valuation consultant must gain a thorough understanding of the risks and the impact on the business.
3. Budget for medium and long-term growth: For a company in an economic downturn, the key to improving a valuation can be long-term planning and annual budgets. It is important to develop a financial plan for the company and to allocate funds for strategic initiatives when the time comes.
4. Increase Marketing and Networking: Increased marketing and networking will drive traffic to the business, increasing its visibility and generating leads. In an economic downturn scenario, it is important to focus on marketing and increase exposure levels.
- Increase organic marketing over ad spend: Advertising can be quite expensive, and any additional costs are scrutinized during an economic downturn. Therefore, to get the most of your investment in marketing, it is best to increase the budget for organic marketing instead of advertising.
5. Don’t discourage employees: During an economic downturn, any negativity toward employees can negatively impact morale and productivity. The business valuation consultant must strive to maintain a positive environment during an economic downturn.
Sharp economic downturns and market downturns can have a major impact on company valuations. The key to ensuring you get the best score from the business valuation is to develop a basic understanding of the industry and the business climate.
Colin McCrea is a Board-Certified Valuation Analyst with years of experience conducting business valuations for clients across a wide range of industries, both corporate (Seed through Series C) and more traditional companies. He is currently with Eqvista.
Figure: Dom Guzman
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