A distressed firm is one that finds it hard to make interest payments and commitments. Some experts define financial distress as companies that file chapter 11(bankruptcy). The conventional business valuation methods, for example the discounted cash flow and relative company valuation approach short cheat the impacts of financial distress on value.
In most company valuation, distress is usually not taken notice of and assumptions implied are mostly unreal about the result of a company not being able to meet its financial goals. However, the business valuation methods that factor in the impact of distress do not do so completely.
For both the relative and discounted cash flow valuation methods, we make assumptions that the companies being valued are going concerns and are exposed to financial distress that are temporary. Moreover, a large amount of value in all discounted cash flow valuation arises from the terminal value, mostly in the future.
In some cases, where the distress in a firm is not temporary, this may mean that the company may not live to see its terminal value. This type of occurrence can cause a firm to be valued above market value. The discounted cash flow method (DCFM) of business valuation does not directly factor in the likelihood of distress. DCFM can be adjusted to make provision for distress in a firm.
A business valuation is always required when a company files for chapter 11, bankruptcy.
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- ?Growth is avoidable
- Firms may not operate as going concerns
- The aftereffect for value in large public firms can be costly
- Small businesses fail because they borrow money to fund operations and cannot pay back
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Source: http://www.theboaconsulting.com/tips-on-valuing-a-distressed-company.html
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