As I surfed around on the internet the other night searching for Black Friday deals (who goes to stores nowadays, anyway?), I couldn’t help but wonder – how can companies sell products at just a fraction of previously listed prices? The answer isn’t terribly complicated. Retailers cut prices to increase interest in products and fan the flame of pent up consumer demand. This concept, coupled with most businesses being closed on this day, results in stores being flooded with consumers on the “biggest shopping day of the year.” In doing so, the retailer generates exorbitantly high levels of volume and, in turn, maximizes bottom line profit. The retailer also expects that it will benefit over the course of shopping season by generating interest and momentum on this all important day. These are all unique factors that are specific to the consumer environment on Black Friday. There’s a lesson here that can be applied to the value of your business. Stay with me…
In any valuation engagement, one of the first questions we ask our client is, “what is the valuation date for our work?” Trust me, we’re not asking this question just so we can have a date on our report. This is a hugely important factor not only from an administrative and logistical perspective, but also from a valuation perspective. To illustrate, consider your 401(k) balance compared to that of 18 months ago. Most of us have felt the pain of significant dilution of our investment values. Our share holdings in those investments may not have changed much during that time, but the underlying values have changed significantly due to the economic downturn. In other words, facts and circumstances change all the time, and with those changes, values fluctuate.
The technical valuation underpinning of the illustrations above is the concept of “known or knowable.” That is, the valuation analyst can only consider facts and circumstances that were known or knowable as of the valuation date. This can cause some interesting challenges and conflicts for the valuation analyst. For example, consider a scenario where the subject company loses its best customer on March 1, 2009. For the sake of argument, say that this customer provided 85% of the subject company’s revenues, the loss of which eventually sent the company into bankruptcy. Also assume that the valuation date was February 1, 2009. By the time the valuation analyst is engaged, the company may be well into bankruptcy proceedings. However, as of the valuation date (February 1), the company may not have been showing any signs of financial difficulty. At that time, the now lost customer was generating revenues consistent with historic levels. Therefore, the valuation analyst cannot consider the fact that the customer was lost at a date subsequent to February 1. However, the valuation analyst can (and should) consider the substantial risk of having such a concentrated customer base. As such, most valuation analysts will include an additional risk factor in the discount/capitalization rate (i.e. the risk rate of return for the company). However, even the application of a very strong risk factor will not bring us to the reality that the company is now worthless. The fact of the matter is, while the company may be worthless (in bankruptcy) at the time the analyst performs his work, it was probably not worthless at the all important valuation date.
This is just one example of a factor that can highlight the importance of the valuation date. However, all of the following (among other things) are considered in the same light: economic environment, the industry, capital structure of the subject, financial outlook, and even turnover of key management personnel. The lesson here is that when you are considering undertaking a valuation engagement, do not take the valuation date lightly. In can make a huge difference in the results of the valuation analysis. Like prices on Black Friday, the value of a given company has very much to do with unique external factors that exist as of the valuation date.
Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Services group at 440-449-6800 for more information.