Selling a Business: Current Market Conditions
21 November 2022: Selling a Business: Current Market Conditions
Are you thinking of selling a business – either as the owner of that business or as a business broker? If so, knowing what the market looks like should be helpful.
We get asked all the time what the market for selling a business is and that question has been popping up with greater frequency lately.
A new report that was just released – and is based on a survey of professional business brokers and M&A specialists – gives us a glimpse of what the current market conditions are and what those of us in the trenches expect in the foreseeable future. But first a little background.
Interest Rates and Inflation
Interest rates are up which means that the cost of operating a business is up. That, in turn, means that, unless sales are up and margins stay the same, profitability is down. If profitability is down, value is down. And if the value is down, either sales prices are down or the number of businesses being successfully sold is down. Or both
All this is currently happening and impacting our market.
Given that most business acquisitions are financed with debt, the cost of that funding directly impacts the profitability of the business and, in turn, its value. And interest rates determine the cost of that funding
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But aside from interest rates, the rate of inflation is also putting downward pressure on profitability and, thus, value, because unless a business can keep its revenue increasing at the rate of inflation and its expenses – particularly its payroll expenses and its cost of goods and services – from increasing beyond their respective historical percentage of revenue, profitability – at least as a percentage of revenue – will necessarily drop.
Few businesses have been able to increase their prices at the same rate as inflation. And no business has been able to do so except as a response to inflation. This means that even if a business is able to increase its pricing, such increases follow by some amount of time the inflationary impact on costs – which are immediate.
Costs, Profitability and Value
In several recent posts, we’ve discussed how interest rates impact operating costs and profitability.
Consider a business that is acquired for $1 million with the buyer injecting $200,000 of his own cash and, because something north of 80% of small business deals involve some seller financing, the seller providing another $200,000. The buyer must then borrow the $600,000 balance of the acquisition cost from a conventional lender. (We will not include any acquisition funding fees in this example.)
If you’ve been following this blog for any period of time, you know that a business must do three things for its owner, two of which are that it provide a return on the buyer’s invested capital and it must be able pay off the acquisition debt – what’s owed to both the seller and the conventional lender.
Not long ago, a commercial acquisition loan could be had for about 4%. Because seller financing is generally in a second position – behind the commercial lender – it’s generally more expensive. In this example, we’ll assume 5%. The buyer will want a reasonable return on his investment so let’s assume that is also 5%. As most commercial loans are for a maximum of 10 years and self-amortizing, we’ll use a 10-year term
Applying these percentages to our fictitious deal suggests that annual debt service for the two loans plus the return required by the buyer total about $123,800.
Rate are higher now – and they’re expected to continue to rise. Rates vary, of course, based on many factors but for our example we’ll use 6.5% for the conventional lender and 7.5% for the seller. We’ll also use 7.5% as the buyer’s required return on his invested capital. Applying these new percentages to our fictitious deal suggests that debt service for the two loans and the return required by the buyer total about $138,750. Depending on the business, the difference could reduce value by between $40,000 and $60,000 – and perhaps more.
Higher interest rates are also increasing transaction costs as the fees associated with obtaining small business loans have been increasing. Buyers are calculating that increased cost into their decision-making and offer processes as they expect a certain ROI for their capital, time, and risk.
What’s the Impact?
So, how is all this impacting the business-selling market?
The just-released report says that sales of businesses in the third quarter of 2022 was 4.5% lower than the previous quarter. Year-over-year, asking prices for small businesses dropped by 13% from last year while sale prices dropped by 14%. According to the report, the decline is a result of sellers reducing prices to help buyers who are now facing rising interest rates and higher acquisition costs.
Some sellers – especially those that have made post-closing plans that can still be implemented with the net proceeds of a reduced-price deal – are cutting their prices while others are delaying their exit; pulling their business from the market and resigning themselves to working for a few more years to continue building their business and wait for the market to improve.
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
The Bottom Line
Our market is like any other – impacted by interest rates and inflation. The real estate market, for example, is taking a beating. But this is the normal ebb and flow of markets, sometimes – as in this case – caused by government actions and policies.
But our market, at least at this point in its evolution, has an interesting backstop of sorts: Baby Boomers.
Baby Boomers are heading for the exits in what we refer to as the Silver Tsunami. Sure, not all of them are able to absorb a 12%-15% decline in the valuation of their business, and they’re the ones who will be staying put for a few more years until they have a business worth enough to support their post-closing plans. But many Boomers’ businesses are in good shape and, though worth a little less than a year ago, these owners won’t be delaying their exit. The golf course, beach or travel beckon.
But all businesses are impacted by the twin problems of rising rates and rising inflation both of which will have negative effects on value.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at joe@WorldwideBusinessBlog.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
We continue to be contacted by small private investment groups seeking small and mid-size contractors in the “trades”; HVAC, electrical and plumbing contractors are in demand. We’re also seeing strong demand of landscape and grounds maintenance contractors.
If any of you know of something that might fit, please let me know.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 500 in the world. He can be reached at joe@WorldwideBusinessBlog.com