While the COVID-19 crisis has seen the share market drop more than 30%, interestingly it hasn’t dropped as much as during the GFC, at this stage.
In the last month, we have seen a small recovery in the share market. There are two key components to determining the gross value of a business (before deducting debt) – the business’s future maintainable earnings or profit, and the required rate of return given the business’s risk and growth profile.
In a private business transaction, the required rate of return is a function of many factors, including the purchaser’s personal objectives. When considering a required rate of return, two factors that weigh most are the revenue growth potential and the riskiness of the revenue streams.
There is also the consideration of alternative options for investing, which could include getting a job and putting the money into the share market, a property or a term deposit. So the required rate of return competes with those alternative options and the purchaser’s personal objectives.
Interest rates are likely to remain low for the foreseeable future and the world will to continue to be a turbulent place. So, for well-managed private businesses, a purchaser’s required rate of return is going to remain similar to the pre-COVID-19 environment.
The change I foresee is the assessment of revenue growth and risk, and the resultant future maintainable earnings by purchasers. None of us has a clear picture of the post-hibernation world. International travel and trade are likely to be very different for a long time. Purchasers will take that into account in their business valuations.
So what are the implications for private business owners? We all need to step up in terms of proactive management of the business’s direction. We need to take a critical view of the “quality of our business earnings”.
Consider how to improve the growth and risk of our earnings, which will have a positive impact on the business valuation. Review the revenue model – more recurring, regular interaction with customers and longer-term revenue relationships with customers are key areas on which to focus.