July 16, 2020
The COVID-19 pandemic and federal Coronavirus Aid, Relief and Economic Stimulus (CARES) Act are having a major impact on business valuations. Those valuation changes can have major financial implications for divorcing couples, estate planning, those looking to buy or sell a business, or becoming an equity partners in an enterprise. It’s important that people consider how valuation changes will affect them financially both now and in the long term.
Business valuations are forward-looking and there are multiple approaches to them. An income approach to valuation applies an opportunity cost of capital to an expected future benefit stream, such as cash flows or net income, while a market approach applies multiples, such as price-to-earnings, derived from reasonably comparable companies.
The pandemic forced the closure of many businesses, such as bars, restaurants, and gyms, while others were able to remain open but at different operating levels. This will have a major impact on cash flow and net income, driving down valuations.
The CARES Act added other considerations into the mix. Changes to tax laws can create one-time surges in cash flow, while the Paycheck Protection Program (PPP) is providing additional funding, much of which will not have to be repaid if conditions are met. These efforts have helped many businesses stay afloat but may not be enough to maintain or enhance their value.
The Business of Breaking Up
For the he approximately 800,000 couples who get divorced each year, they are looking at major potential changes in the value of their real estate, investment portfolios or jointly owned business interest, and this could alter how much one must pay the other in the divorce settlement. If you started divorce proceedings at the end of 2019 and determined your asset and business values before February 2020, you should consider updating those figures for the economic effects of COVID-19.
Recent economic changes may have reduced the values of their home, shared investments, or businesses, and it may be many years before the values of those assets return. Depending on how those assets are divided, one spouse may be set up for a bigger rebound in the future or paying more than they should.
Divorcing couples should look at their settlement plans to determine whether they need to consider re-valuing their jointly held assets before concluding the dissolution of their marriage.
Estate Considerations
For those managing large estates, now may be an opportune time to transfer ownership stakes of a business, real estate or investment holding company to family members or a trust. The IRS limits your lifetime giving exemption to $11.4 million.
The COVID-19 pandemic has pushed some stock prices down, forced many businesses to close or cut back operations, and may have reduced real estate values. But like many investments, these drops are likely temporary.
Investment holders who have been considering passing their holdings on to family members or a trust can take advantage of the current lower valuations to transfer more shares or a greater percentage of their ownership stake and stay under IRS limitations.
There are other valuation considerations as well, such as discounts for lack of marketability or lack of control, that can be applied in some situations to increase estate tax savings. Marketability discounts reduce the market value of closely held or restricted shares of enterprises that do not have an active market, while lack of control discounts reduce the market values when the ownership interest lacks control over the entity.
Buying or Selling a Business
For those looking to buy into a business, now may seem like an ideal opportunity, as one can get in at a lower cost. But it can be more complicated than that, depending on the type of business and other equity partners.
If existing owners or partners do not need immediate additional capital, they can opt to hold off on taking in new partners until the value returns or maintain their initial price with expectations that the business will recover quickly.
For those looking to sell a business, they have to weigh several factors, including a potentially reduced sales price resulting in a lower tax bill on the sale and how fast they need to get out.
Stay safe,
David Gibbs, CPA, CCIFP, MBA
Partner
McCarthy & Company
Source: CARES Act Causing Business Valuation Concerns for Divorces, Estate Plans and Partnerships. James Gallagher. CPA Practice Management Advisors. July 9.
Disclaimer: This alert is for informational purposes only and does not constitute professional advice. Information contained in this communication is not intended or written to be used as tax advice, and cannot be used by the recipient to avoid penalties that may be imposed under the Internal Revenue Code. We strongly advise you to seek professional assistance with respect to your specific issue(s).
