During a recent webinar, a question came up as to whether or not valuation analysts should be separately identifying a risk rate associated with the impact of COVID-19 on a subject company. This notion has been kicking around for a while, apparently surfacing back in the 2008-2009 financial crisis. The webinar presenter, Jim Alerding (Alerding Consulting), cited from an article written during that time: “Distressed entities generally have higher risk profiles and lower profitability levels compared to their healthy competitors, and a proper discount for distress, usually at least 20%, therefore must be built into the valuation.”

While most valuers would certainly agree with the first part of this statement, the idea of a rule of thumb for a separate discount is another matter. “I’m not sold on this,” says Alerding. “It’s better to build the risk into the cash flows and discount rate.” Of course, when you do that, you have to be careful not to double count the risk. Plus, Alerding advises that, when you do come up with a final cost of capital rate, you need to take a step back and ask whether it makes sense for the subject business.

David Lurvey, Timothy O’Brien, and George J. Schultze wrote the article quoted above, “Hidden Treasures: Techniques for Valuing Distressed Enterprises,” which was published by the Turnaround Management Association.

A recording of Alerding’s webinar, Valuing Distressed and Impaired Companies in the Time of Coronavirus, is available if you click here (purchase required for nonsubscribers).