Subsequent Events: What was “Known or Knowable” on the Valuation Date?
The COVID-19 pandemic has affected the value of many privately-held businesses. Some have closed their doors permanently, while others have found market opportunities and prospered.
Hindsight is 20/20. When valuing a business in today’s uncertain conditions, experts must put themselves in the shoes of hypothetical investors and consider only relevant information about the pandemic that was known (or knowable) on the valuation date.
Searching for Relevant Information
When determining the fair market value of a private business, hypothetical willing buyers and sellers are presumed to have made a reasonable investigation of the relevant facts. In addition to facts that are publicly available, reasonable knowledge includes information that a reasonable buyer or seller would uncover during the course of private negotiations over the purchase price.
Subsequent events — those that happen after the valuation date — may be considered when valuing a business if they’re reasonably foreseeable and relevant to the question of value. Examples of potentially relevant subsequent events include:
- A pending offer to purchase the business or an interest in the business,
- A bankruptcy filing,
- The emergence of new technology or government regulations,
- A natural or human-made disaster,
- A pending legal investigation or lawsuit,
- An initial public offering, and
- The loss of a key person or major contract.
Not all subsequent events are reasonably foreseeable. For example, you probably can’t predict when your company will be affected by a fire, a data breach — or a pandemic.
A subsequent event that’s unforeseeable as of the valuation date also may be considered if it provides an indication of value. An example would be a sale of stock that happens a month after the valuation date. However, unforeseeable subsequent events are usually relevant only if they occur within a reasonable time period and at arm’s length.
Factoring COVID-19 Into Business Valuations
The valuation date typically corresponds with the subject company’s quarterly or annual financial statement date. For that reason, December 31 is a common cutoff for data that’s used to value calendar-year businesses, especially for smaller entities that don’t issue interim statements.
Experts consider external market conditions that existed on the valuation date when valuing a business. COVID-19 is an ongoing crisis that’s having an ongoing effect on many types of businesses. What exactly was known or knowable about COVID-19 at the end of 2019 — or the end of each quarter of 2020? The answer depends on how hypothetical investors would have perceived the situation on the valuation date.
For example, some scientists suspect that COVID-19 existed prior to December 31, 2019, but the World Health Organization didn’t declare a public health emergency until January 30, 2020 — and it wasn’t upgraded to a pandemic until March 11, 2020. Even at the end of March, when Congress passed the CARES Act, many small business owners remained hopeful that the crisis would be resolved during the summer — and that government relief efforts would keep them afloat until then. Unfortunately, the crisis wasn’t resolved during the summer, and many businesses continue to struggle or have been forced to close.
What’s “reasonably foreseeable” about market conditions that affect a subject company depends on the nature of its operations, its location, and the valuation date. For example, some states have continued to prohibit many businesses from reopening at full capacity — or have reinstituted restrictions in response to COVID-19 resurgences — while other states did largely reopen, starting in the summer.
Likewise, some sectors have endured long-lasting setbacks, including restaurants, travel, and entertainment. Others — including grocers, big-box retailers, videoconferencing platforms, and delivery services — have grown substantially during the pandemic.
Seeking Expert Opinions
When you hire a business valuation expert, it’s important to share all information that could potentially be relevant to the value of the business. This includes information about subsequent events that affect value or provide an indication of value. Once the valuation expert is aware of this information, he or she can determine whether it’s appropriate to consider when valuing the business interest.