During COVID-19, companies were particularly hard hit by the economic impact of the pandemic. To help companies stay afloat during this time, the U.S government introduced several government-sponsored programs to eligible businesses to keep them operational during the pandemic.
If you’re considering buying a business, investing in a business, or selling your business, you should consider the impacts of these programs on historical earnings and the value of the business. If not done, or not done correctly, you can seriously overpay for the acquired business. In this article, we look at why and how these pandemic-related items impact EBITDA.
The first thing to consider is the three primary types of government assistance offered during the COVID-19 pandemic:
An important factor when discounting PPP loan proceeds from EBITDA is to look at the timing. If the PPP loan had been applied for but not yet approved in the historical financial statements, then it should not be included. However, in most cases, the PPP loan has been approved and disbursed.
Next, consider the forgiven portion of the PPP loan. Forgiveness can only be assured if the funds are spent following the rules and regulations outlined in the PPP. This means that when calculating EBITDA, the amount that has been used following these rules and regulations should be included. Any remaining amounts are considered as debt and included in the balance sheet. You’ll want to check that the unforgiven portion is being paid.
Another important consideration is the tax impact of PPP loan forgiveness. According to the IRS, if the PPP loan is forgiven, it is not taxable income. However, the expenses covered by the loan also cannot be deducted, reducing the tax benefit associated with such costs. So, when calculating EBITDA for a company with PPP loan proceeds, it is essential to factor in the tax impact as well.
Employee Retention Tax Credit
For the ERTC, refunds are achieved by reducing the payroll tax liability at the time, or by retroactively amending previously filed payroll tax reports. In the case of amended 941 payroll tax filings, the credit will likely show as income in the year in which they were calculated. They should always be excluded from any analysis of historical earnings, since they don’t relate to operations. Most deals involve a valuation based on a multiple of historical earnings. As such, including this non-operational income can seriously skew the calculations and cause an inflated valuation.
Also, qualified wages used to claim the refundable payroll tax credit are no longer allowed to be taken as a deduction on the company’s income tax return. So, check to ensure income tax returns were amended for each year in which the ERC was taken in order to properly reflect adjusted taxable income. For example, if a company was eligible to claim the credit in 2020 and 2021, both years of income tax returns must be amended.
When considering one-time items like PPP loan proceeds or ERTC, you’ll also want to ensure that you obtain indemnifications from the seller to cover you in case things come back to bite you. If the PPP loan forgiveness wasn’t handled properly, that can be something you’ll have to deal with.
More importantly, there are scams far and wide regarding the ERTC program. In fact, the IRS has warned employers several times to be wary of third parties who are advising them to claim the Employee Retention Tax Credit when they may not qualify. Taxpayers are always responsible for the information reported on their tax returns. Improperly claiming the ERTC could result in taxpayers being required to repay the credit along with penalties and interest. So, you’ll definitely want to get indemnifications for this. If you’re a seller, you should expect the potential acquirer to request them.
Understanding the impacts of pandemic era programs on EBITDA when buying a company is essential for companies that are considering purchasing or investing in existing businesses. Failing to discount the impacts of these proceeds appropriately can have a significant impact on the valuation of the business.
It’s crucial that companies seek out expert guidance to ensure that they account for all variables when calculating the true value of a target company. By doing so, companies will make better-informed purchasing decisions, improving the likelihood of success during these challenging economic times.