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<strong>Storm Clouds on the Horizon</strong>

Storm Clouds on the Horizon

Still a Seller’s Market for Business Owners Looking to Exit?

By Chris Jones, President, Sunbelt Business Advisors

The markets just closed out the worst week since the pandemic. Inflation is at a 40-year high, prompting the Federal Reserve to raise rates by 75 basis points. Further rate increases are expected in 2022 as the Fed tries to tame inflation. Will we enter a recession, and if so, what does that mean for small and mid-size business owners who have been considering an exit?

First, some ground rules. Roughly 80% of privately held companies are under $5 million in revenue. We’re going to focus on these smaller companies, not on big private companies or public companies. Stay tuned for another article addressing this topic for companies up to $150 million in revenue.

Our firm sells many of these under $5 million revenue companies. We affectionately call them main street businesses. These small but mighty companies drive 50% of the U.S. economy. These business owners are asking us more and more: “Is it a good time to sell?”

These entrepreneurs likely remember 2008. During the 2008 financial crisis, the sales of main street companies were devastated. Banks tightened lending, business revenue and profitability declined, which depressed business values, and business buyer confidence dropped. Business owners who had planned on selling at that time had to wait two or three years while their businesses recovered to pre-2008 values.

But before we jump to the latest economic concerns, let’s talk about that other crisis: COVID-19.

The COVID-19 Hurricane

To talk about current economic conditions without talking about COVID-19 is like talking about World War 2 without discussing Pearl Harbor. COVID-19 was an unprecedented shock to our economy. We may not comprehend all the consequences for years. Here’s what we do know:

  • COVID-19 hurt some businesses and helped others, especially industries deemed “essential”
  • The lockdowns and pausing of our economy caused severe supply chain issues
  • Business owners who successfully navigated COVID-19 were still able to sell their companies

Our firm, Sunbelt Business Advisors of Minnesota, had a record year of business sales in both 2020 and 2021. Once the initial lockdowns ended, we found that business buyers still very much wanted to buy.

Lenders were also bullish and treated COVID-19 like a hurricane. Yes, it caused great devastation, but they largely ignored the COVID-19 months, treating them as a one-time event. They focused instead on a company’s performance as it emerged from COVID-19.

Buyers and lenders continued to do what they have always done: look to the probable future performance of the company. They looked closely at value drivers such as customer concentration, suppliers, systems & processes, employees & management, and financial trends as indicators.

If the growth opportunities were good and the risk was reasonable, buyers bought and lenders lent.

Money Supply, Inflation, and Market Uncertainty – the Next Hurricane?

Over the course of the pandemic, the government injected over $6 trillion into the U.S. economy.

Consumers were now sitting on an historic amount of cash. Consumer service companies, like restaurants, were closed. Consumers focused instead on consumer goods, driving up demand. Sunbelt has sold many e-commerce companies that doubled or tripled sales due to this surge in demand for consumer goods.

Economists are hotly debating whether it was this historic government spending or the supply-chain disruptions that drove inflation.

It is worth noting that most industrialized countries have lower levels of inflation than the United States. These other countries also implemented significantly lower amounts of COVID-19 spending.

No doubt, COVID-related supply shocks have caused some price increases. However, supply constraints do not cause the same across-the-board price hikes that true inflation causes. Now, all prices are rising, including wages, and the inflation is persistent.

Why does this matter to business owners and buyers?

The U.S. government spent 26 percent of GDP on COVID relief. Other industrialized countries spent 10 percent (France, South Korea, Norway) and at the time of this article have only four percent inflation.

Business sellers and business buyers should anticipate further inflation and additional interest rate hikes by the Federal Reserve. Higher interest rates are of special importance to business buyers.

Business Value vs. Cost of Capital

So, what is the argument for it being a seller’s market? If you are a business owner, here’s the good news:

  • If your business is profitable and you expect it to remain profitable, it is almost always sellable.
  • Business buyers outnumber business sellers by an enormous ratio. In our Minnesota market, we launch approximately 20 new businesses for sale per month. At the same time, we receive 200-300 buyer inquiries every month.
  • A record amount of capital remains in the market.
  • Profitable businesses are still selling quickly, often with multiple offers.
  • One of the most common metrics for business value, multiples or earnings, has remained steady.
  • Multiples in some high demand industries have grown, indicating a flight to quality as buyers become more discerning.

Here’s the bad news for business owners:

  • Most buyers, whether private equity groups, strategic buyers, or individual investors, typically use some combination of equity (cash) and debt. Rising interest rates make that debt more expensive. Buyers must put in more cash or try to push down the seller’s price. Business owners who wait to sell might lose leverage every time the Fed raises the interest rate.
  • If your business is especially sensitive to inflation and interest rate hikes, such as a company serving the residential real estate market, your window to sell for the best price might be narrowing.
  • If your business is recession-sensitive, a decline in sales or profitability could lead to a cooling of buyer interest and/or bank interest in your deal. Sellers who wait too long to sell may have to carry more seller financing or other buyer-friendly terms.

Summary

Remember, a profitable business is almost always sellable. Buyer demand remains high. Banks remain highly interested in business loans. The COVID-19 hurricane did not dampen buyer demand. A recession will make some buyers more cautious, but buyer demand will remain strong.

However, as a business owner, you must understand how inflation, rising interest rates, and a possible recession could impact your company and then be ready to illustrate to potential buyers how your company is insulated from this risk or has hedged against this risk.

Buyers will try to compress price as the cost of capital increases and as they perceive more risk in the marketplace. Follow a process that maximizes the number of qualified buyers so you don’t leave money on the table.

The sale of your company is a major personal and financial decision. Whether you are thinking about selling now or riding out the next hurricane, we encourage you to find out what your business is worth in today’s market. The best business owners know what their business is worth.


About the Author

Chris Jones is President and co-owner of the largest business brokerage firm in the country, Sunbelt Business Advisors of Minnesota. Mr. Jones has been selling companies for over two decades across diverse industries. He believes that private business ownership is part of the American Dream and that by helping transfer business ownership, we help our communities, economy, and future generations. When he’s not helping sellers and buyers of companies, you’ll find him traveling with his wife, recovering from his latest mountain biking accident or paddling in the Boundary Waters Canoe Area.

About Sunbelt Business Advisors of Minnesota

The Sunbelt Business Advisors Minneapolis office is the largest office in the Sunbelt network with a staff of over 50 advisors, associates, analysts, and business development representatives. In 2021 the firm was recognized by the International Business Brokers Association as the #1 firm in the country and the first firm in history to sweep all three first-in class awards. Sunbelt provides services to business owners interested in selling their businesses, assistance with merger and acquisition activities, complimentary business value assessments, and advice to business owners seeking to maximize their life’s work when they exit. The firm provides business brokerage and mergers & acquisitions services for companies with revenues from $500,000 to $150 million. More information is available at www.sunbeltmidwest.com (<Under $5 million revenue) and www.tnma.com ($5 – $150 million in revenue).

Additional Resources

https://www.wsj.com/articles/recession-probability-soars-as-inflation-worsens-11655631002?reflink=desktopwebshare_permalink

https://www2.deloitte.com/us/en/insights/economy/us-economic-forecast/united-states-outlook-analysis.html

https://www.sunbeltmidwest.com/poised-for-exit-podcast-lets-elevate-your-business-value