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June 18, 2020 Article 3 min read

Understanding the impact of COVID-19 on the valuation of private equity investments is crucial for accurate financial reporting and strategic decision-making. PE firms should revisit valuation policies and consider these key factors and opportunities. 

Business woman wearing yellow dress shirt standing in the lobby area of a building looking out the window.Private equity firms are looking at how the current pandemic will impact the value of portfolio investments, especially after massive declines in market values of large publicly traded PE funds as a result of COVID-19. Understanding the effects of the crisis on portfolio company valuation is crucial. Management, strategic decision-making, and upcoming financial reporting, be it quarterly or annually, all rely on valuations that reflect the latest market conditions . PE firms can also expect greater scrutiny by investors, auditors, and the SEC.

But how you approach valuation looks a lot different today — the status quo no longer holds true. As a result, PE firms should be reviewing and enhancing their valuation policies. Take the following implications and opportunities into account:

1. When will the economic impact from the COVID-19 pandemic subside and valuations return to normal?

It’s the question everyone is asking, and PE firms are no different in wanting a definitive answer. Of course, it’s complicated. The answer is going to differ by industry and by company within every industry. Some firms will recover quickly, some will take longer, some will need to make permanent changes in how their business is run to get their value creation strategy back on track. No one-size answer exists.

2. Don’t rely on the usual valuation methods.

Historical pricing strategies and transaction benchmarking are far less relevant in our new, highly dynamic normal. The volatility in market valuation means multiples implied from publicly traded companies no longer are as effective as a rule of thumb for privately held firms. P  E funds will need to make changes to how they apply traditional valuation methods and go beyond the use of EBITDA multiples, DCF, LBO  , or comparable transaction methods you’ve relied on in the past.

When using an income approach to determine value, the heightened uncertainty in the current environment means greater risk, which may warrant a higher discount rate. This also means you’ll need to avoid “double dipping” and ensure you carefully balance lower forecasts with appropriate discount rates. 

3. Broaden scenario analysis for valuation forecasting.

PE firms may want to look at more scenarios than in the past when developing forecasts. Certainly, circumstances might improve and some of your portfolio businesses might recover quickly, but what if it takes a few months or several years? Forecasting multiple optimistic and crisis-mode scenarios — and several in between — can add greater depth to your valuation analysis.

4. Gather and document your valuation data points.

Stakeholders are likely to look for more information and explanation to justify how you arrived at your valuations. You’ll need to gather and document support for your conclusions much more so now than before. And don’t be surprised if auditors ask for more formal impairment testing  and look closely at your carrying values for goodwill and intangible assets. If you’ve done valuation in-house previously, now might be a good time to consider independent third-party verification.

Stakeholders are likely to look for more information and explanation to justify how you arrived at your valuations.

5. Look out for PE opportunities amid COVID-19

With respect to valuations, the current crisis isn’t all gloom. If performance is down, you may be able to reduce or eliminate earnout liabilities. Note, though, you’ll probably need an updated valuation to support that.

While yet to be seen, lower market pricing for acquisitions may provide an opportunity for more favorable pricing on acquisitions, as sellers adapt to a new reality or identify opportunities that a partnership with PE could bring to rebuilding value and achieving future growth.

In conclusion

Don’t wait to look at your valuation methods and policies. Auditors, investors, and other stakeholders will most certainly want to see additional valuation support for many of your portfolio companies. When you need it, an independent third-party valuation can be important to audit, investor relationships, and earnouts. It can validate your numbers and help allay concerns about the pandemic’s impact on your investments as you prepare both for upcoming financial reporting and your fund’s future.

COVID-19: Adapt faster, emerge stronger.

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