EBITDAC is a facetious term for Earnings Before Interest Taxes Depreciation Amortization and COVID. I first discussed it in this column back in April of 2020, with an update on the impact of PPP loans in May of that year.
A subscriber to our ExitMap® coaching tools recently asked “What are other advisors doing about the impact of 2020 on business valuations?” He was specifically concerned about a client who had a losing year in 2020, but there are few businesses that weren’t affected in some way.
I took the opportunity to reach out to Brent Heflin, the Director of Business Development for BizEquity, to ask how their software was handling it. He was kind enough to share a white paper by their CVO, Scott Gabehart, on their algorithm updates. I’ll return to that document in the “Approaches and Solutions” segment below. (Full disclosure, we are BizEquity subscribers, but received no consideration for this mention.)
The Dual Impact of COVID
As Mr. Gabehart very legitimately points out, COVID wasn’t detrimental to all businesses. I personally work with a company whose revenues increased tenfold as a result of an order by a multinational for a component to a COVID-related product. The owner asked me “So, is my company worth ten times what it was before?”
Of course, it isn’t. The uncertainty of future revenues, combined with discounting for his inordinate (over 90%) concentration in one customer, would offset any rational increase in the valuation of his short-term cash flow. In the meantime, he just has to be satisfied with banking record income.
Nonetheless, a surprising percentage of our clients had a banner year in 2020. Was it COVID? Was it in spite of COVID? Or was it just because their industry was on the sidelines of COVID, and they are seeing the long-term growth effects of running a good company? It’s hard to determine, much less to assign a numerical value.
Consideration of Follow-on Effects
What about other COVID-related impacts on businesses? Of course, hospitality and travel were affected directly. So were home improvement and home-brewing suppliers, although in the opposite direction. But how do you factor in the supply chain disasters that have followed?
If “You’re on mute” was the most used phrase in 2020. “supply chain issues” has to be the winner in 2021. How can you value an auto dealer who has no inventory, or a builder who can’t deliver a product because of lumber or labor shortages?
If you formerly shipped a container of goods from Asia for $2,500, and today it’s costing you $25,000, is that a blip? Will freight costs return to the old norm, a new but lower norm, or is this just a new reality? If you formerly paid $12.00 an hour for labor, and now you are paying $17.00, do you think pay rates are going to return to the old levels?
I have numerous clients who are again posting record years. They are trying to identify how much of that is due to pricing, and how much is real growth. If prices drop next year, how will they account for a corresponding fall in revenues?
Approaches and Solutions
The BizEquity white paper lists a number of technical tweaks to their software to account for changes in the market. Their industry factors are adjusted daily based on the Russell 2000 indexes of industries. They are following anxiety factors, and swings in the future cash flow projections of businesses.
Their job is to deliver an accurate estimate of value based on what similar companies are selling for. It’s not their role to guess what the value of your business might be if factors change again in the future.
On an individual basis, a number of advisors are throwing out 2020 in those industries where regulatory shutdowns severely curtailed revenues. This approach may be valid if the business has since rebounded to previous levels. Alternatively, you can account for the anomaly year as a one-time gain or loss.
EBITDAC isn’t Going Away
In any (and every) case, the validity of any estimate of value is reflected in what a buyer will pay. The fact is, a continued influx of cheap financing, combined with increasing urgency among aging Boomers to leave their businesses, still fuels a strong acquisition market in some sectors.
The impact, both immediate and follow-on, of COVID-related factors isn’t going to magically evaporate. The effects of the virus may support some explanation, but businesses in decline will still sell for less, and those that are growing will realize more.
EBITDAC can be addressed in a number of ways, but it will be part of every valuation and business analysis for years to come.
