Should Post-Pandemic M&A be based on 2018 Cash Flows?

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Prior to the COVID-19 pandemic, developing future cash flow projections from a data point 2-3 years old would have seemed absurd. But post-pandemic it will become the norm.

A company’s most recent financial data has historically served as the best indicator for projecting future anticipated cash flows. However, at no point prior has that most recent financial data been burdened by a global health crisis that required a total economic shutdown. This is the dilemma currently facing business acquirers and M&A going forward.

It can easily be reasoned that a company’s 2020 operating performance will not be reflective of its earnings potential going forward due to the COVID-19 shutdown (in most industries). As a result, buyers must either include a COVID adjustment into the baseline of their projections to more accurately reflect anticipated performance sans pandemic or look for another baseline. Determining an appropriate COVID adjustment is difficult. How much deterioration of the business was the result of the COVID pandemic? How much was natural attrition? How much was attributable to other factors such as changes in technology or customer preference? Should we look to 2019 for guidance? This is a slippery slope.

Moving to 2019 data in an attempt to treat business sellers fairly and not undervalue their businesses, may create an unintended consequence. It can be reasonably argued by acquirers that 2019 results were over-inflated. 2019 was booming! It was one of the best business environments most industries have seen (at least in the United States) for a long time. This combined with the amount of available capital inflated deal multiples and resulting valuations. So, referencing 2019 results for a starting point doesn’t fix our problem, it changes it.

I therefore submit to you a resolution for post-pandemic M&A. 2018 operating performance will be the best indicator for projecting future anticipated cash flow. Times have changed. What once would have been considered absurd will be the new normal.