Valuing a business is hard enough when things are going well, but valuing a business that has been impacted by the COVID-19 pandemic can be another kind of tricky at best. Joining host, Domenic Rinaldi, in this episode, to talk about how best to get through the motions of these troubled times in your business is Alexandra (Alex) Reed Lajoux, Ph.D., M.B.A., the founding principal of Capital Expert Services, LLC. Alex discusses the things buyers and sellers should be thinking about when it comes to valuations during this pandemic and how business owners should look at a potential exit. She also shares some advice for buyers out there on how to approach a potential seller without looking like taking advantage of the current tough situation we are all in. Listen in on this important conversation to learn how to navigate through these times and come out stronger than when you entered.

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Business Valuations In This Time Of COVID-19 With Alexandra Reed Lajoux

Valuing a business can be hard enough when things are going well. Valuing a business that has been impacted by the COVID-19 pandemic will be tricky at best. We’re being joined by a real expert, Dr. Alexandra Lajoux. She has many accomplishments that I couldn’t even begin to cover those in this intro. She’s accomplished so much and been involved in the M&A world. At a high level, she is the Founding Principal of Capital Expert Services, past President of Alexis & Co. She serves on the boards of several organizations and has authored or co-authored all of the books in the McGraw-Hill The Art of M&A series covering strategy, valuation, financing, structuring, due diligence, integration, as well as financially distressed M&A. Dr. Lajoux, welcome to M&A Unplugged. I’m excited to hear your perspective on the current and unfolding M&A environment. 

Thank you, Domenic. It’s a pleasure to be here. I’m eager to hear your questions.

That intro doesn’t do you justice. You have accomplished and involved in so much. Fill in the blanks a little bit so people have a good sense of your background and what you’ve done. We’ll dive in and start talking about how buyers and sellers should be thinking about valuations during this post-pandemic environment. 

It’s funny preparing for this interview, it took me on a trip down memory lane. I realized that the valuation of businesses, including distressed businesses is much a part of my life. I grew up in a household of an entrepreneur involved in M&A. He was an M&A consultant, and he created and sold several businesses. Stanley Foster Reed was my father. He founded the publication, Mergers and Acquisitions. Even though in my early life, I had other aspirations, I wound up in the field. He was my original mentor. Buying and selling companies was the story of our life and pretty much sent me to college. My lifelong career was with the National Association of Corporate Directors. I’m retired there, but I worked there for 30 years.

That was an organization that started out small, grew organically, but then took leaps and bounds growth when it acquired another organization. I saw how that worked and then I have been a bit of an entrepreneur. I started a business and stay with it. I appreciated what I heard about the personal gratification business in an interview with you. That’s been my story for those businesses. I’ve always been aware as you’ve mentioned in some of your writings and interviews that one should always think about the potential value of a business when it’s going to be sold. I have some thoughts about that as well. That’s the story of my life from a lens of business valuation.

I don’t meet many people who grew up around M&A. You have a unique perspective almost your entire life around this. This is a unique time and I’ve thought about the parallels between this and the Great Recession of 2008 and the crash in 2000, 2001. Somehow or another, this feels different. We’ve had our entire supply chains shut down. Most of the economy shut down with the exception of central businesses. Have you ever seen in all your years anything that might look like this?

I have not, Domenic. I agree, it does seem to be unique. However, some of the lessons from past crashes that we’ve all survived do hold true. I remember a financial advisor of mine. He was with UBS and he’s now with Wells Fargo during the worst of the economic crisis. He said, “As long as people are willing to get up and go to work, there will always be value, an economy, and prosperity.” In other words, we can rise from those ashes. We can look at the balance sheet, the cashflow, and the income statement. You can all look grim and gray.

If the owners, customers, suppliers, employees, and contractors have a will to continue and have built up goodwill in the most general sense, there’s always hope. I’m a huge optimist on the value of businesses, no matter what. If you think about it, Domenic, thinking of all the high-tech companies that are always pre-revenue, they have zero revenue. They have nothing but lots of liabilities and costs. From a financial statement, point of view, they look terrible, but perhaps they’ve come up with some idea that has great value, sizzle and they can attract capital. That phenomenon is not dead. Value is quite ephemeral.

I’m glad to hear this message. I do think that’s a great message and lesson because even in our M&A practice, we’re getting calls every day from clients, buyers, sellers and asking us what’s happening. “Is there any activity? Where are the lenders on deals?” Interestingly enough, we have continued to maintain momentum. People are way more cautious, deals that were going along smoothly. People who put the brakes on a bit, but they haven’t stopped. They’re making sure that they’re doing thorough due diligence and we’ve closed a couple of deals. It highlights and illustrates your message that there’s always value out there. 

Sometimes you have to look for it a little bit deeper and it takes a little bit longer, but there’s always value out there. Maybe we could take this conversation to look at an environment like this, where some companies are doing better than ever because they happen to be in sectors that the demand is increased. That’s few and far between. Most are holding their own or they’ve seen substantial decreases in revenues. If you’re a buyer or a seller, maybe we’ll take it from a seller’s perspective first, how should you be thinking about the value of your business while we’re in the midst of this pandemic? How should people approach looking at a potential exit and the value of their business?

Business Valuations: As long as people are willing to get up and go to work, there will always be value. There will always be an economy. There will always be prosperity.

I’m an optimist about value. It drives me crazy when people say, “It’s only me, myself, and I. I have had a great run. It’s made me money, but the business has no intrinsic value.” I beg to differ. In most cases, first of all, there’s a brand value that gets built up that has a value attached to it. If there’s been a website and a lot of traffic to the website, if someone coming along and a potential acquire is not into building websites and creating Google site stability, that has value. The people the business employees or engages as contractors or even vendors, that have some value. Perhaps the company has a tax loss that an acquirer wants to use in the future.

That acquire happens to be one of those rare businesses that have high revenues. Perhaps the company has established a great track record of governance paperwork, paying all the licenses, and all the fees, possibly even has an IPO paperwork started or in the case of a shell public company. It costs a lot of money to build the paperwork for business and somebody else might want to come along and take that over and save him or herself pains. Also, the old-fashioned idea of replacement costs, “I’ve spent $1 million building this company. You want a similar company. Do you want to do it by yourself with nowadays dollars? Wouldn’t it be better to take it from me and then move forward and save yourself a lot of time?”

There’s the idea of the value of the founder’s willingness to stay. If the founder who is a great be-all and end-all is willing to stay for a while and bring customers forward, bring that goodwill forward, that has value right there. In terms of the actual sale, the founder doesn’t have to say, “I want all the money right upfront in cash.” The founder can have the possibility in a negotiation to say, “I’ll take a contingency pay. I don’t take a part of it. My business is worth excellent. I’ll take part of the value. I’ll prove my point and going forward, I’ll share the risk with you. I’ll take a payout, but it’ll be a lower payout if things don’t go as I optimistically predict.”

I’m always a big fan of lawyers, those contracts, how do you define the act of God? If God forbid COVID strikes, the parties are well aware of how you’re defining the act of God. Does it include a pandemic, etc.? These things might sound technical and narrow, but taken together, that’s the entire experience of M&A. That is what keeps our economy going. If you think about it, most companies are privately held. Acquisitions are much more common than we realize. We even encounter like, “There were 49,000 acquisitions announced globally in 2019.” That’s only announced acquisitions that were worth $5 billion or more, but think of the thousands of businesses that change hands every day. You’re the one who has the catbird seat for that.

What you’re highlighting for the M&A Unplugged audience is traditional valuation methodologies of a multiple of EBITDA. Not that that’s the only way to value a business, but most companies take that approach is you’re looking at a multiple of your EBITDA. We’re going to have to have a recalibration of that during this time. We’re going to have to rethink other ways to value a lot of the things that you’re pointing out or you’re also suggesting that maybe you stick with a multiple of EBITDA. The EBITDA being pre-pandemic EBITDA and the owner, if they believe that the business is going to come back, agrees with the buyer. They’re going to take a good portion of that in contingent payments, whether that be an earn-out or a contingent note because they believe in their business and they believe it will come back. If it doesn’t for some reason, the value probably winds up being what the true value should be. If it does come back, everybody’s happy and there is full valuation, a realization. Is that right?

Yes. I’m glad you mentioned EBITDA because that comes and goes as a fashion. I know even the Financial Accounting Standards Board calls that a non-GAAP metric and the SEC is a memory of it, but it’s great metric earnings before interest taxes, depreciation, and amortization. Ultimately, that’s an accounting term. Accounting, as you know, can be somewhat managed or manipulated. Even in Wall Street, they love that discounted cashflow. That is clear. It’s obvious but rather than being manipulated on paper, that can be affected by new policies. For example, pretend that I borrowed X amount of money to start a record label and then I put music out there and I’m getting a cashflow every month from CD Baby.

If you compare the payments on the debt that I’m paying to the incoming cashflow, I have positive cashflow. That’s already a start right there and if you see discounted cashflow in the future, what does it look like? If I have the possibility of interest rates are getting lower or went down to zero and the value of money increases, that discounted cashflow will make my business look good. EBITDA is not the only measure. I’m not disrespecting it, but I’m saying also discounted cashflows good. There are comparative transaction metrics. One of the great treasure chests of valuation techniques are the courts.

People are always suing that they were either shareholders assume because they say the management overpaid for an asset or a buyer is suing because the buyer overpaid or the seller is suing because maybe a minority shareholder of the seller was underpaid. In the courts, they bring in expert witnesses such as appraisers to give an opinion as to whether or not the price was fair, fairness opinion. It doesn’t have to be a fancy investment banker to be an appraiser. You find all interesting defenses of prices, theories, and there’s a multitude of things. You’ve got to know that if someone devotes life to building a business, there’s cut to be value there because God is a just God. How could it not be? How could it not have value?

There isn’t one methodology. There are multiple methodologies to arriving at a value. Even if you’re using them all as litmus tests to make sure that you’re getting within a range of value, that’s a great approach. Dr. Lajoux, let’s shift gears here a little bit. We’ve talked about the sellers and maybe the sellers having to shift their mindset, think about all of the intrinsic values that are in the business, and maybe think differently about how they receive the consideration. Maybe not all upfront, but over a period of time. Let’s shift gears to buyers.

Buyers are going to be cautious in this period. They don’t know what they’re walking into. They don’t know what the future holds. They don’t know how quickly a business is going to rebound, yet we are in this environment, where there are tremendous amounts of capital sitting on the sidelines, interest rates at historic lows, and acquisition as you pointed out being a tremendous way to grow. What should buyers be thinking about during this pandemic as they approach acquisitions and the valuation of those acquisitions?

Business Valuations: There are all kinds of different ways to accomplish a more collaborative approach to prospering. So why wouldn’t any company be open to the idea of combining with another company in some way, shape, or form?

I agree with you that they do have to be cautious. It all starts with the buyer’s management team asking itself, “What is our strategic plan? What is our core business? What is our vision? What is our mission?” That energy and those values propelling forward to say, “Is this something we can do on our own or should we find a partner? If we find a partner, should it be any joint venture or should it be through an acquisition? Should it be a merger?” There are different ways to accomplish this more collaborative approach to prospering. Why wouldn’t any company be open to the idea of combining with another company in some way, shape or form? When it comes to spending money, as you say, it’s there. It’s available.

You can borrow it. The interest rates are low. In any event, you’d have to give a business plan to your lender anyway. That’s a good way to soul search and say, “Is this something we want to do?” The buyer would look at, “If we decide to acquire this company, are we going to take an ownership position and let it run itself and get some payments out of it? Are we going to combine our operations to some degree?” That’s where all of the great writing and thinking about merger integration comes in because it’s key. Do we combine sales forces? Do we combine brands?

Do we consolidate branches and all of that? When you have mergers of equals, you save money because sadly there’s downsizing. Other times when you have mergers of complementary companies who can prosper together but at the same time, there might be some clashes. Mergers are risky. There’s no doubt about it. They’re highly risky. The riskiness is quite overstated. There’s a popular statement that 80% of mergers fail. Every good analytical scholarly piece I’ve read said it’s about a 50/50. That’s still risky, but it’s hardly a guaranty of failure.

I didn’t know that statistic even 50% makes you take pause. You go back. Better have your plan crystallized and your integration plan as well. We know through experience in our firm that even the best mergers on paper, unless there’s a good, solid integration plan, you’re headed for rough waters. Your buyer in the market is uncertain about what the impacts of the pandemic are going to be and how long it’s going to be, whether or not there’s going to be a second wave. What happens to supply chains? How do you approach companies that have been impacted by COVID-19? Are there extra precautions you take, advice that you would give to buyers out there as they look at businesses that have been impacted?

My approach is based on the idea of diplomacy. If you know that a company is struggling and it’s losing revenues, it’s losing people, you don’t want to appear to be a vulture taking advantage of their vulnerability. It’s the moral of the sellers so important. In approaching a potential seller, you want to let them know how much you value what this company has accomplished, the value of what you carry forward brand, and so forth. I know it sounds counter-intuitive because eventually, you want to negotiate the lowest possible price. You’d think you’d want to act indifferent and put them down.

I guarantee you because selling in and of itself is somewhat of a traumatic event, you need to create conditions in which the healthiest relationships can occur. You don’t know if you don’t merge, you might decide to form a joint venture. You need a lot of goodwill there. I would say that thinking about COVID, know that it’s done a lot of damage already to these companies, and these are probably going to be willing to sell accordingly. Make sure that you convey the idea that everything they’ve done so far has been positive. This is why you’re approaching them and then engage in a dialogue of what you can do together.

It’s interesting about COVID-19 because remember it was many years ago when the idea of the uncontrollable risks, the unpredictable risks, the Black Swan and Desert Storm, we’ve talked about the unknown unknowns. That’s what we’re dealing with COVID. We have an unknown unknown, and yet there’s that wonderful grid where you have unknown known, the unknown unknown. Right there over the unknown unknown. What have you got to lose? If the world itself is coming to an end, follow your bliss and everything will work out.

The point that you’re making about the morale of the seller is such an important one. We have a motto in our office that, every good deal starts with rapport. Sometimes buyers come in and they want to look at the memorandums and the financials. They don’t spend enough time building rapport with the seller. Invariably if there’s an agreed-upon letter of intent if that deal hits bumpy roads, the relationship wasn’t there to get through those bumps. During a pandemic, it’s even more important. Unfortunately, this environment does bring out in some people the worst. We get the calls every day from people saying, “I want a business that’s down on its luck. That’s what I’m looking for.”

You can tell they want to pounce. It’s part of the market and it’s always going to be there and there’s no way around it. If you’re in it for the long haul and you expect the cooperation of that seller, you have to approach it as you said, understanding the morale of the seller and keeping their spirits up and trying to build rapport. These are all great points. Alexandra, let me take it up a level here. At the highest level, you’ve lived through any number of down cycles. You’ve been in M&A. It sounds like you’ve been exposed to it almost your entire life. What advice do you have for people at the highest level that they should take away from this conversation?

What comes to mind is, believed in yourself. I know that sounds general, but whether you’re a seller or you’re an acquirer, stand in your integrity. Believe in yourself. Believe in everything you’ve accomplished to date. You’re going to acquire well and you’re going to be a great acquirer. You’re going to ask the right questions. You’re going to have the right outcome. If you’re a seller, everything you’ve done in your life, you’ve done it right. You’re coming into this negotiation with strong integrity. As I say, believing in yourself, attitude and moral are important. The diabolical nature of a pandemic or an economic crisis, and we’re facing both, is it saps you of your confidence, strength, vision, channel, and ability to communicate. These are real risks. One has to keep all of that at bay and focus on all the positives you’ve accomplished, whether you’re an acquire or a seller.

Business Valuations: Selling in and of itself is somewhat of a traumatic event. You need to create conditions in which the healthiest relationships can occur.

We’re keeping this high level. There’s probably so much more we could explore, especially as it relates to diligence, integration, and the banks. I know you have deep knowledge and experience in all of those areas. Is there anything related to diligence, integration or lending that is worth mentioning here?

The word that comes to mind here is contracts. Don’t leave it to the lawyers to read and understand all the contracts. Contracts with lenders, employees, and vendors. When you’re doing due diligence with any corporation is that it’s a bundle of contracts. It’s nothing more or less. The corporation you’re buying has made certain promises and you as an acquire will probably inherit all of them. Some of them will hamper you, empower you and you need to make the distinctions. Your choice of an attorney is important. You want an attorney to guide you in understanding the fullness of the contracts. Please don’t delegate it to an attorney who doesn’t include you because there’s so much opportunity and risk within those contracts.

I interviewed two attorneys and we did point-counterpoint that one attorney took the seller’s side on an issue. The other one took a buyer and we talked about reps and warranties. Reps and warranties and indemnifications are going to be front and center during this pandemic. They have always been important, but there’s going to be a tremendous amount of importance on this and how they’re worded and the survival periods. Your point is well taken. Hire advisors, whether they’re attorneys or accountants or whoever they are that have deep experience and make sure that you understand everything that’s happening. Don’t take a back seat. It’s tremendous advice. Dr. Lajoux, this has been tremendous. We’re going to wrap up here. If people in the community wanted to get in touch with you, if you could leave some contact information so they can reach out to you. 

I’ll make one touchpoint and that is that I forgot to distinguish between tangible and intangible assets. I find that the category of intangible assets is endlessly interesting. There could be a case in which you want to buy a company. It has some intangible assets that have not yet been protected. There’s no patent, no copyright but there could be. It’s a trademark, I should say. There are about copyright in this day and age certainly. That’s a whole goldmine right there. A way to get a hold of me, if anyone wishes to is [email protected]. If you google my name, Alexandra Lajoux, you’re going to see lots of business, a little bit of politics and music and that’s me. I’m the only one out there on Google.

Thank you again for being here. It’s been such a pleasure. 

Thank you, Domenic.

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About Alexandra Lajoux

Alexandra (Alex) Reed Lajoux, Ph.D., M.B.A., is founding principal of Capital Expert Services, LLC, connecting law firms and other professional services firms with diverse business specialists to serve as expert witnesses or consulting experts. She serves the National Association of Corporate Directors (NACD) as chief knowledge officer emeritus. At NACD, Dr. Lajoux served as editor-in-chief of NACD’s flagship Director’s Monthly for more than 15 years, and helped NACD develop the world’s largest library of director-centric thought leadership publications.

Dr. Lajoux has authored or coauthored all the books in the McGraw-Hill Art of M&A series, covering strategy, valuation, financing, structuring, due diligence, and integration, as well as financially distressed M&A and bank M&A. Her articles have appeared in Capital Insights, Financier Worldwide, NACD Directorship, and Risk & Compliance. She has been a speaker/panelist at events hosted by the Association for Corporate Growth, the National Association of Corporate Directors, the U.S. Chamber Center for Capital Markets Competitiveness, and Worldwide Business Research (InvestOps) among others. She heads the Alexandra Lajoux Corporate Governance Series at Walter De Gruyter GMBH, and with lead author Peet van Biljon has written Making Money: The History and Future of Society’s Most Important Technology (December 2019).

Capital Expert Services, LLC (CapEx), founded in 2016, is a community of corporate governance experts dedicated to helping law firms, consulting firms, and private equity firms find experts in areas outside the ordinary.

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