Valuation of distressed firms is complex and highly context-specific. It requires modifying standard approaches and robustly addressing heightened risk, uncertainty, and often, restructuring or liquidation scenarios.
Key Steps and Methods
- Determine Premise of Value: A blend of analytical rigor and professional judgment,
- Going Concern Value: Assumes the business will continue to operate, supported by a feasible turnaround or reorganization plan.
- Liquidation Value: Assumes the business will cease operations, and assets will be sold piecemeal. Liquidation can be orderly (over time) or forced (fire-sale), each yielding very different results.
- Market Approach (Comparable Company and Transaction Methods):
- Analyze multiples (e.g., EV/EBITDA, P/Sales) of similar, preferably distressed, firms, adjusting for the target’s specific risk and situation.
- If only healthy peers are available, apply steep discounts to account for higher risk of failure or uncertainty.
- Income Approach (Discounted Cash Flow):
- Use a revised DCF, truncating or probability-weighting future cash flows to reflect the increased risk and uncertainty.
- Incorporate the likelihood of different scenarios: turnaround, partial recovery, or failure. Sensitivity and scenario analysis is crucial.
- Asset-Based Approach:
- Focused on net asset value after deducting all liabilities. Important in cases where recovery prospects are slim or asset sale is inevitable.
Special Considerations
- Probability of Distress and Default: Estimate the likelihood that the firm will fail, using bond ratings, financial ratios, or scenario probabilities. Apply these probabilities to weight various outcomes.
- Adjustment for Distress: Make explicit downward adjustments to base values to reflect uncertainty, risk, and rapid asset disposal (distressed sale values).
- Impact of Litigation, Employee Retention, and Operational Disruptions: Account for added risks that can affect value, including pending lawsuits, key personnel departures, and supplier or customer attrition.
- Market Sentiment: Distressed firm prices are often heavily influenced by investor sentiment and liquidity in the relevant asset market.
Distressed valuation is ultimately a blend of analytical rigor and professional judgment, with scenario analysis and stakeholder negotiations often shaping the final outcome. It demands clear articulation of assumptions and transparency about risk and uncertainty throughout the process.
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