Known or Knowable – Something to Keep In Mind

One recent morning, a buddy of mine called me for a quick catch-up chat. After a few minutes in and running out of good topics to cover, he asked me what I had for lunch the night before. Considering we’ve been quarantined for multiple months and have already discussed every (worthy) Netflix/Amazon Prime show in our prior chats, I felt it was a legitimate topic. Oddly, the answer didn’t just come to me and after a few moments my answer was: “I don’t remember.”

Many of you who either perform valuations or have had a valuation performed before, probably have heard the term “known or knowable.” It’s a somewhat nebulous term, especially when you first learn of it. However, it is a well-established valuation principle that requires us to consider only information that was known or could have been known as of a specified valuation date when determining a value.

In recent months, we’ve had multiple interesting discussions with our valuation clients on what was “known or knowable” as of a specified valuation date (i.e., date of value measurement). These discussions can get challenging because there are a myriad of factors that come into play when we, as humans, are trying to recall our past thoughts, actions, and events. These factors can include recency bias, mistaken memory, forgetfulness, ulterior motivations or personal agendas, and many more. This is particularly true when there have been major events like the COVID-19 pandemic that have significantly altered our experiences, including our business outlooks.

Events on this scale affect us in a variety of ways over a period of time, and the impacts can be negative or positive. Note some key dates in the COVID-19 pandemic timeline and the performance of the Dow Jones Industrial Average (“DJIA”) as follows:

• January 11, 2020 – China reported its first death from COVID-19 (DJIA: 28,824)
• January 21, 2020 – The first known case of COVID-19 in the United States was reported (DJIA: 29,196)
• January 31, 2020 – The World Health Organization issues a Global Health Emergency (DJIA: 28,256)
• February 3, 2020 – United States declares a public health emergency due to COVID-19 (DJIA: 28,400)
• March 11, 2020 – WHO declares COVID-19 a pandemic (DJIA 23,553)
• March 13, 2020 and After – States start issuing stay-at-home orders (DJIA drops to 18,591 on March 23, 2020)
• March 27, 2020 – President Trump signs CARES Act into law, providing a $2 trillion economic stimulus package (DJIA: 21,636)

As I write this, the DJIA is at 26,000. From a market perspective, the impact of the COVID-19 pandemic has been highly volatile over a short period of time. A valuation performed as of one date on the timeline above can be significantly different from a valuation performed as of a different date on that same timeline. This kind of situation creates a conundrum when determining what was known or knowable as of a specific valuation date. Consider these scenarios:

• Company A acquires Company B in a transaction that closed on February 2, 2020, which is also the valuation date for the assets acquired. Company B started experiencing a significant downturn as a result of COVID-19 soon after the closing date. Company A management was aware of COVID-19 but didn’t know what the full impact of it would be when they closed the transaction. They started performing the purchase price allocation in May 2020.
• A shareholder leaves Company C in January 2020. Company C has to buy out the departing shareholder at the fair market value of the shareholder’s ownership interest as of date of departure. The company was negatively impacted by the COVID-19 pandemic in the months after the shareholder left. Company C engaged an expert in June 2020 to perform a fair market value analysis.
• The owner of a local online grocery retailer filed for divorce in April 2020, which establishes the date of valuation. The business grew significantly due to greater demand as a result of the COVID-19 pandemic. The company is expected to sustain the higher level of business for the foreseeable future, especially since there are plans to expand services into neighboring towns. The owner engages an expert in early May 2020.

In each of these scenarios, one can claim some degree of knowledge of COVID-19 and its possible impacts as of the respective valuation dates. However, to what degree can they support? Considering all of the psychological factors that come into play, how can one ensure or prove that the information was known or knowable as of the valuation date?

Here are some tips:

• Tell the story – A story can tell you the numbers. Open a Microsoft Word document or turn on a voice recorder and tell the story of the business, as you can recall, through to the valuation date. Ideally, you’d have a prior benchmark date to start from such as a date of a prior valuation or the day you started working with the company. Make sure to stop the story once you hit the valuation date.
• Check documents and past correspondence – Every day, we create new documents (i.e., presentations, memos, etc.) and send plenty of emails, text messages, and other correspondence. We can review such documents and correspondence to jog our memories and provide support for our assumptions.
• Research – “Knowable” can mean that even though you didn’t know something as of a certain date, someone else could have. It can also mean that you can consider impacts related to events that had not occurred as of the valuation date, as long as you can reasonably foresee the impacts based on the facts and circumstances that were known as of the valuation date. Therefore, some research can go a long way in defending what you claim as known or knowable. News articles, industry reports, filings of public peers, etc. that can be obtained through a web search or other resources can lend support for the assumptions you make in performing a valuation.

Other major events such as the passage of the 2017 Tax Cuts and Jobs Act also muddied the waters around what was known or knowable. It is safe to assume there will be many more such events in the future. “Known or knowable” is not a scientific term, but it is a vital concept for valuations. Being cognizant of it as you perform a valuation or have a valuation performed can help you develop a sound and defensible value for whatever your purpose is. It can help you avoid the pitfalls of the unknown.