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Authored by Bruce Hutler and Paul Daddio

We are in unprecedented times. The COVID-19 pandemic’s impact on our society and on businesses around the globe has been rapid, severe and complex. The ultimate duration and depth of the current economic downturn is unknowable, casting uncertainty across the U.S. and global economy and depressing valuations across most industries.

Though each business will be impacted differently by the current economic downturn, it is certain that the valuations of small- to mid-sized closely held businesses in particular—which generally lack the capitalization, diversification, and general resources of large public companies—have been quite significantly affected. As valuation and transaction advisors to thousands of businesses, we are seeing this firsthand. Other factors such as lack of availability of debt and private equity investors moving to the sidelines will also place downward pressure on valuations.

In such an environment, now may be an optimal time to pursue certain estate planning strategies that will provide for the future financial well-being of loved ones. In other words, now may be the time to effectuate wealth transfer strategies that will minimize tax implications and protect the passage to family members of financial assets, ownership interests in closely held operating companies and real estate and investment securities holding entities, and other property. Also considering that the Estate & Gift Lifetime and GST exemptions are $11,580,000 per person, for some families there may never be a better time to pursue these opportunities.

The following provides a summary of how the current economic downturn is impacting the valuation of closely held businesses.

Income approach

The income approach is fundamental to any valuation analysis. Typically taking the form of the “Discounted Cash Flow Method,” under the income approach, value is determined based on a projection of the future financial performance of a business, discounted to present value using a “discount rate” estimated to reflect the rate of return investors would require to compensate for the level of risk inherent in the business.

In the current environment, projection modelling — which is a challenging task in any time—has taken on an added layer of complexity. Because we are in such unprecedented times, it is difficult to use historical financial and operating trends as reliable indicators of future performance. The impact of the economic downturn will certainly have a negative impact on the forecasts of nearly all companies. However, careful support for projections is always critical. Key inputs and assumptions must be logically and adequately supported to withstand scrutiny and include both top-down analysis (macroeconomic factors, aggregate customer demand, competitive landscape, etc.) and bottom-up analysis (volume and pricing, cost of inputs/direct labor, overhead, operating metrics, etc.).

The added level of risk and uncertainty faced by investors today has certainly contributed to declines in the value of companies. Professor Aswath Damodaran of New York University estimates that the equity risk premium (ERP)[1] was 6.0% at the start of April, up from 4.9% at the start of February.[2] While this may not sound like a drastic difference, the downward impact on the valuation of companies of this increase is quite significant. Discount rates must be carefully considered in relation to overall market risk and company-specific risk factors and supported for each valuation, as every business will be impacted differently by the current environment.

Market approach

The market approach arrives at an indication of value based upon multiples paid in recent transactions of ownership interests in guideline companies similar to the company being valued in terms of industry and operations. Guideline valuation multiples can be based upon acquisitions of companies or stock transactions of publicly traded companies. Value multiples from these guideline public companies and M&A transactions are then applied to the financial information of the subject company to arrive at an indication of value. 

As we mentioned previously, we have observed a significant decline in the value of the overall S&P 500 and the resulting multiples. For example, as evidenced in the chart below, the median last 12 months (LTM) price-to-earnings multiple for the S&P 500 has declined by over 20%, from 22.2x on January 20, 2020, to 17.2x on March 20, 2020, resulting in lower investment portfolios and lower valuations. 

S&P 500

The M&A market has also been deeply affected. While not enough time has passed to have observable private company transaction multiples reported, based upon conversations with industry participants and our own observations as transaction advisors, while some transactions are closing with or without a change in terms, continuing uncertainty has led many deal processes to halt or to be put “on pause.” The current situation may cause buyers and sellers to reassess valuations and adjust pricing mechanisms, resulting in lower implied multiples for the transactions and corresponding lower indications of value for closely held companies.

Additional valuation considerations

Another important factor that could potentially result in lower equity values is the increased use of interest-bearing debt, as many companies have needed to draw on their line of credit or other forms of leverage to meet short term cash flow needs. The U.S. government has also provided potential sources of additional debt, such as the Paycheck Protection Program loan or the Economic Injury Disaster Loan. The use of additional leverage causes a decline in the net value of the equity of a company.

Finally, discounts for lack of marketability that are applied to the value of fractional interests in the ownership of closely held companies and interests transferred could increase due to increased volatility and illiquidity in the marketplace. Lack of marketability discounts measure the diminution of value attributable to the lack of a ready market for a closely held ownership interest. An ownership interest in a closely held company has no ready market given the lack of a secondary market, and there are significant impediments to marketability due to the restrictions on the transfer of the ownership interests. The market-clearing price of a non-marketable investment is discounted relative to the price of its otherwise identical, but marketable, counterpart. Risk is commonly accepted as a key factor in the determination of discounts.

Potential estate and gift planning opportunities

We are currently in an unprecedented situation creating a uniquely optimal time to pursue certain wealth transfer and estate planning strategies to transfer additional wealth at depressed values before they begin appreciating again. Specifically, consider pursuing the following opportunities:

  • Gifting and other transfer strategies of ownership interests in closely held operating companies while typical valuation methods would lead to lower valuations;
  • Creation and transfer of ownership interest in real estate and investment securities holding entities (LLCs and FLPs) while the public securities markets are depressed and real estate values have declined due to higher capitalization rates and lower income; and  
  • Electing to value the estate’s assets as of the alternate election date (IRC 26 U.S. Code Section 2032) for estates for individuals who have died within the past six months.

There is reason to believe that the window of opportunity to take advantage of these strategies may be relatively short. A recent Reuters poll of over 50 economists suggested the U.S. economy is forecast to rebound by 10.5% Q3 2020, followed by a 3.2% expansion in 2021.[3] A favorable low interest rate environment and access to financing, and continued digital transformation and technological disruption are expected to continue to drive the economy and transaction volumes.


The uncertainty surrounding COVID-19 has forced many individuals to consider and address their current health and estate planning concerns. The situation also provides a unique opportunity to consider unprecedented wealth transfer and tax-minimization opportunities as the result of unanticipated depressed assets values.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

[1] Incremental rate of return investors require above risk-free securities such as Treasury Bonds to compensate them for the risk of investing in equity securities.

[2] Duff & Phelps also increased its U.S. ERP recommendation from 5.0% to 6.0% when developing discount rates beginning on March 25, 2020 and thereafter; however, Duff & Phelps notes that several of the economic and financial risk factors were already present during the week of March 9, 2020.

[3] Coronavirus-led global recession to be deeper than thought but hopefully short: Reuters Poll, Reuters, Business News, April 3, 2020.

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