Almost a year into the COVID-19 health and economic crisis it has become apparent that some businesses are thriving in the current environment. Others, although a long way from turning a profit, have no problem attracting investment due to the low interest rates and accommodative policy of the Federal Reserve that drives business valuations of IT companies ever higher. However, many of the small to medium-sized businesses struggle with depressed demand for their products and have to rely on government help to make it trough the crisis. For the businesses in highly affected industries such as hospitality and commercial real estate, that also have high levels of debt, the government assistance might be too little too late, forcing them to file for bankruptcy protection. So what are our bankruptcy valuation

In most cases bankruptcy does not mean liquidation and the bankrupt business are expected to continue their existence after debt restructuring. How much debt gets written off and how much equity in the restructured entity each creditor gets is typically decided in bankruptcy court, which is a US federal court. Even if the creditors have agreed on a pre-packaged deal, the bankruptcy court still needs to approve the deal in order to make sure that the interests of all stakeholders are being considered. Creditors can be secured by some or all of the assets of a business, be unsecured, and ranked in terms of seniority that determines which creditor is going to get paid back first.

When it comes to bankruptcy, business valuations are used to determine the value of the business in question upon exiting the bankruptcy process. That value is used to determine the recovery rate creditors get and how much debt, if any, the restructured entity can support. Since senior creditors are first in line to recover their investment, it is in their interest that the bankrupt business is not valued as richly. For example, a company that has $150 million pre-bankruptcy debt, comprising of $100 million senior debt and $50 million junior debt, is valued at $100 million, then the senior creditors are likely to receive 100% of the equity. If the business in question is to be valued at $150 million then the senior creditors would get 66.66% of the business and the junior creditors would get 33.33%. Given that business valuations greatly impact the recovery of creditors in bankruptcy cases, the work of valuation professionals tends to be closely scrutinized in court. However, with the fluid and uncertain situation brought by the COVID-19 global pandemic, even courts and valuation professionals are unsure what assumptions can be made about the future. The problem is further compounded by the fact the business most affected by the measures to slow the spread of the virus are the ones most likely to file for bankruptcy. That includes restaurants, hotels, cruise lines, hairdressers, tattoo shops, brick and mortar retailers and office buildings among many others. So, what can valuation professionals that represent interested parties do to determine the economic value of a business adversely affected by COVID-19 and serve their clients’ interest, while convincing the courts in the reasonableness of their valuation models?

First and foremost, valuation professionals have to get very familiar with the industry in which the bankrupt business operates and know what exactly led to the poor financial performance prior to the restructuring. Was it caused directly by measures taken to combat the spread of the virus? Or was it caused by the changing consumer preferences triggered by the pandemic? Are those likely to revert or the changes are likely to be somewhat permanent? For example, the cruise line industry is currently under ban to sail from US ports, a measure directly related to preventing the spread of the virus. That has brought the revenues in the industry down to zero but would revenues and profitability bounce back quickly once the measures are lifted? In my opinion, the answer is that revenues might bounce back quickly, given the aggressive promotion from cruise lines. On the other hand, profitability is likely to remain below pre-pandemic levels for long due to the discounts and extras, such as an open bar, included in cruise packages that are currently sold. Once used to the discounts and extras, passengers are unlikely to accept their removal from packages sold after the pandemic has retreated.

Another important consideration when valuing a business in restructuring is to account for any government support during the pandemic. Has the business already received funds form the US government? In what form and under what terms? Is the business likely to receive more funds in the future and how would that impact its valuation? Both the US government and the US Federal Reserve Bank have taken unprecedented measures to support business activity in the US. Support can come in the form of forgivable Paycheck Protection Program (PPP) loans, other disaster loans and direct payments, as well as guaranteeing credit facilities as is the case with the Federal reserve. These programs have certain conditions which have to be taken into account by the valuation professional in order to determine the scope of government support a business in bankruptcy might be receiving. For example, a business that has received a PPP loan in the past might not be eligible for the 2^nd round of the program and other assistance if it has become delinquent on the 1^st round.

The third important consideration would be regarding historical data that is used in valuation models. Data regarding market multiples and comparable transactions that was collected before the pandemic might distort the value of a restructuring business. While data available since the start of the pandemic is limited and inconsistent it should be given greater weight when valuing businesses that have been either positively or negatively impacted by COVID-19. A note of caution should apply to stock market multiples of companies in “hot” industries such as electric vehicles, software and online retail that have befitted from the influx of retail “day traders”, leading to unreasonable and outlandish valuations.

Overall, a competent valuation professional would be a great asset to any attorney that finds themselves in complex bankruptcy proceedings, having to defend the interest of their clients against an opponent that is looking to skew a business valuation to their benefit. In order to convince a court and prevail over an adverse party’s biased valuation report, a valuation professional would have to consider the rapidly changing industry dynamics, the complex role of the US government, and the reliability of data.

If you are a bankruptcy attorney in need of a skilled valuation expert, contact us, your trusted valuation firm.