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Determining ‘fair’ business value – Adjustments for heightened uncertainty

Business valuation already previously frequently resulted in arguments about the ‘correct’ or ‘fair’ value. In our times of war in Ukraine, high inflation, rising interest rates and increasing market volatility the issues related to determining business value are taking on greater significance.


Current market conditions mean that great uncertainty prevails as regards future developments and many businesses are not able to make reliable forecasts for the coming years. Yet, for the dominant valuation models, such as the income capitalisation method or the discounted cash flow technique, it is the future developments that form the basis for the mathematical determination of the business value. The question that arises is if, or how valuation models should be adjusted to take into account the above-mentioned uncertainties. Within the scope of business valuation, allowances can be made for risks by adjusting the aforementioned business valuation models – which are based on the calculation of net present value – both on the level of the numerator (the income or cash flow to be valued) and of the denominator (the capitalisation rate).

Impact on the cash flow to be valued or the income to be valued

It is basically common practice to derive forecasts from the most recent past of a business. However, in view of the events of recent years, for many businesses the ‘typical’ financial year was several years ago. Moreover, it might be necessary to take into consideration changes in the business model or the market environment so that it would not make sense to extrapolate the past into future years. Consequently, detailed forecasting for a business constitutes a major challenge for current business valuations. 

In a statement, of 20.3.2022, the Expert Committee on Business Valuation and Economics (Fachausschuss Unternehmensbewertung und Betriebswirtschaft, FAUB) of the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer, IDW) recommended carrying out a review of business forecasts in order to ascertain if the current uncertainties have been adequately taken into account, or to work towards having these taken into account or, as the valuer, to do so yourself where necessary. Furthermore, when drawing up the forecasts it may be helpful to create different scenarios. Here, for example, it might be appropriate to adjust the cash flows that have been reported to date for state subsidies and financial support, as extraordinary effects for the years with actual data, and not to take these into account for the years with forecast data. If sectors, such as retail or tourism, are going to be affected by the consequences of the crisis also in the long term, – for example, because of fundamental changes in consumer behaviour or in the distribution channels – then these effects should likewise be individually analysed and factored into the forecasts. In this connection, particular diligence is called for when deriving the perpetuity. Here, for the detailed forecasting phase it would appear to be prudent to choose an appropriate length of time until the business achieves a steady state.

Recommendation: Small and medium-sized enterprises, in particular, frequently do not prepare any standardised business forecasts. However, such forecasting can be helpful, especially during times that are fraught with uncertainty. This would apply, in particular, if a company succession is pending, or the sale of a business is being planned. Standardised forecasting also forms the basis for effective financial management and liquidity management.

Impact on the capitalisation rate

Furthermore, for a fair business valuation it is crucial to determine an appropriate capitalisation rate. As interest rates are currently rising this will tend to result in an increase in the capitalisation rate and, thus, in falling business values. In this respect, the IDW’s Expert Committee, in its statement of 20.3.2022, pointed out that in the case of the long-term present value of future profits methods [Zukunftserfolgswertverfahren] (such as the income capitalisation method or the DCF technique) the capital market data should be valued on the basis of long-term returns analyses even in times of crisis. Short-term fluctuations and possible overreactions in the capital markets should be regarded as transient indicators of sentiment and not necessarily long-term ones. Consequently, the IDW does not see any need to adjust the methodology that has been hitherto used to determine the capital costs. 

Blanket risk premiums on the capitalisation rate have been rejected by the IDW and also other leading valuation practitioners. Instead, risks should be taken into account in the course of forecasting and, where appropriate, in specific risk scenarios. The debt situation of a business that has changed as a result of the crisis will be reflected when determining the capitalisation rate. Moreover, it is already apparent that certain sector-specific beta factors have undergone crisis-induced changes.

Conclusion: Impact on transactions and prices

The above-mentioned aspects are increasingly leading to valuation problems for businesses that are under pressure to sell, for example, for reasons of upcoming succession planning. Currently, the business values that have been determined, frequently, cannot be realised in the transaction market. That is why it is important for a vendor to develop a realistic price expectation. The scenarios that are created in the course of the business valuation can be taken up once again during the purchase price negotiations. In view of the current uncertain market situation, in this context, payment mechanisms are frequently being used where portions of the purchase price have to be paid at a later point in time and these payments are contingent on certain conditions being met.

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