Inflation has hit 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 considering an exit?
Eighty percent of privately held companies are under $5 million in revenue and are often called “Main Street businesses.” These small but mighty companies drive 50 percent of the U.S. economy. These business owners are asking 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 had to wait two or three years while their businesses recovered to pre-2008 values.
Throughout the coronavirus pandemic, the government injected more than $6 trillion into the economy.
Consumers were now sitting on a historic amount of cash. With consumer service companies like restaurants being closed, consumers focused on purchasing consumer goods. Many e-commerce companies doubled or tripled sales due to this surge in demand.
Economists are hotly debating whether it was the historic government spending or the supply-chain disruptions that fueled inflation.
It is worth noting that most industrialized countries have lower inflation levels than the United States. These other countries also implemented significantly lower amounts of COVID-19 spending.
The U.S. government spent 26 percent of GDP on COVID relief. Other industrialized countries spent 10 percent (France, South Korea, Norway) and now have only 4 percent inflation.
Business sellers and buyers should anticipate further inflation and additional interest rate hikes by the Federal Reserve.
How does this matter for business owners and buyers?
For business owners, here’s the good news:
—If a business is profitable and is expected to remain profitable, it is almost always salable.
—Business buyers outnumber business sellers by an enormous ratio — it is common to have 10-15 buyers for every business on the market.
—A record amount of capital remains in the market.
—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. Business owners who wait to sell might lose leverage whenever the Fed raises the interest rate.
—If a business is susceptible to inflation and interest rate hikes, such as a company serving the residential real estate market, the window to sell for the best price might narrow.
—If a business is recession-sensitive, a decline in sales or profitability could lead to a cooling of buyer interest or bank interest in a deal. Sellers who wait too long to sell might have to carry more seller financing or other buyer-friendly terms.
Potential business buyers will try to compress prices as the cost of capital increases and as they perceive more risk in the marketplace. Therefore, business owners must understand how inflation, rising interest rates and a possible recession could affect their companies and then be ready to illustrate to potential buyers how they have insulated from this risk or hedged against it.