Watch forecasts with an eye to the fact that the business may be smaller than it was
"You really have to be attentive to forecasts, and less on history, as we go forward," says Jim Alerding, discussing distressed or impaired companies on today’s BVR teleconference. He suggests being very aware of failing products, customer concentrations that may diminish, and other indicators that suggest that a smaller version of the current company may be the best option. “Capital structures may change, too,” he says, and higher cost of capital can be expected as small businesses in trouble move away from traditional asset-based lenders who may cut them off.
Ironically, for distressed or impaired companies, the market approach may not be of much use—transaction databases like Pratt’s Stats don’t focus on distressed assets, and trying to use the guideline public company method can also result in wildly off-base conclusions. So, the asset approach, and perhaps a liquidation premise of value, might become the most dependable route to a supportable conclusion. One approach would be to consider a “going concern” premise of value, but footnote what the effect of a liquidation premise might be. This is particularly true if a company’s in trouble, but management has no active plan to liquidate (because they’re ignoring reality, or believe they can survive extreme debt or other risks).
Industry data...from sources like BizMiner or from industry associations...become critical. Appraisers need to get on the phone with these sources to make sure they really understand what’s happening.
“Banks are finding any excuse they can to raise rates, and they’re ignoring LIBOR to do so,” says Bob Shortle. “That’s true,” agrees Alerding. “One bank may just call in loans, and say ‘go to another bank.’ There are no other banks to go to for new lines of credit.” This forces management to make harsh decisions they may not even be able to grasp at the time of the valuation date.
The negatives are easy to contemplate, but JIm Ewart points out that the terrible economy can increase value as well—a fact appraisers need to watch. “We’re seeing a weeding out. If your subject company is likely to survive, it may actually be in a stronger competitive position at the end of this cycle, and that needs to be reflected” in cautious but nonetheless optimistic forecasts. “Take a hard look at the supplier base, and at the customer base, to determine if your company will be one of the winners.”