Selling a Business: Head Winds or Tail Winds?
26 June 2023: Selling a Business: Head Winds or Tail Winds?
We’re constantly asked about how certain economic, financial or demographic issues are impacting the market for selling businesses.
Some of these questions come from business owners seriously considering selling while others come from professionals in related industries such as accountants, business consultants and financial planners. Every once and a while we opine on the subject in a post. The one you’re reading is the latest.
There is a good deal of uncertainty in the market. It is, I’m sure, a surprise to no one that, aside from whatever issues a particular business may have, a multitude of externalities impact the process of selling a business and business owners could rightfully assume that any of these issues might have an effect on the value and/or sell-ability of their business.
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If you’d like to learn more, email me at jo*@Wo*******************.com
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As interest rates rise, will valuations be impacted? Will financing be more difficult to secure? Will the movement of the public stock markets impact the availability of acquisition capital? Is inflation effecting seller or buyers? What is the level of competition in the current environment? And do any of these issues impact financial buyers differently than strategic buyers?
There’s no way a single post can cover all that and still be a “quick read” but let’s take a look at some of this.
Interest Rates
All else being equal, the cost of money – interest rates – can impact business sales in two ways; first, by lowering valuations and second, by eliminating some potential buyers who would have qualified for financing a year ago but now find qualifying more difficult.
In fairness, there are some very smart people in our industry that make a reasonable argument that both of these concerns are overblown; That a doubling of rates – from, say, 4.5% to 9% – has a minimal impact on value.
For instance, the difference in annual interest of a 10-year, self-amortizing $800,000 acquisition loan at 9% versus the same loan at 4.5% is only about $22,000 which, if all other numbers are unchanged, reduces Discretionary Earnings by about 5%. But that 5% will impact the valuation arrived at by any qualified business broker or appraiser and will likely impact the seller’s price expectation.
As to any impact on the number of potential buyers that can qualify, we agree that annual interest of $121,600 versus $99,500 by itself might not have a material impact. However, as rates have risen, lenders have also tightened up their standards arguably resulting in a smaller number of qualified buyers. It is not impossible to think that this can effect what a seller will get – and how long it will take to get it.
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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
Granted, business buyers have access to alternative forms of financing and if a buyer is turned down by a conventional lender, there are options; most notably, private lenders. However, such options are almost always more expensive. If the conventional lender wants 9%, the private lenders will be looking for more making the annual interest expense even higher and Discretionary Earnings lower
And private lenders generally don’t offer 10-year terms meaning a buyer will need to refinance in the relatively short term.
Competition
We consider competition in two ways: how many buyers are in the market and how many desirable businesses are coming to market to meet the demand.
As to buyers, an important cohort is private equity. We’ve been receiving an ever-growing number of inquiries from private equity groups (PEGs) and we’ve seen a noticeable lowering of the minimum financial performance requirements of the businesses they target; they are looking at smaller businesses.
PEGs – the ultimate financial buyers – have received an enormous amount of capital from their investors in recent years and the fund managers have to deploy those dollars within a certain period of time or return that capital to those investors. This creates opportunity as well as pressure. Investors expect, and in most cases require, that their investment will be invested in a timely manner in quality opportunities that are likely to provide a handsome return. This suggests that demand for some businesses will act as a counter-weight to offset some of the possible weakness that results from higher rates.
(The Brokers Roundtable℠, an online community created and hosted by Worldwide Business Brokers, has scheduled a live interview with Roland Davis, of Davis Business Appraisers. We’ll be discussing the ins and outs of business valuations and equipment appraisals including what’s needed for a business valuation and how a valuation can be used when marketing a business. Be sure to join this informative discussion – 3.00 PM (Eastern/New York) Thursday, 20 July. At the conclusion of that discussion there will be a Q&A during which attendees can get their questions answered by a pro. But you’ve got to be a member to attend. You can sign up for The Brokers Roundtable℠ here.)
As to the number of desirable business available to buy, there appears to be a limited supply of such businesses and, at least at the moment, an oversupply of qualified buyers, particularly when PEGs, search funds and strategic buyers are considered. This suggests a seller’s market – at least within certain industries.
But the oft-touted “Silver Tsunami” – the retirement of Baby Boomers and the projected flood of businesses coming to market – is still expected to break on the shores of commerce over the next 10 years or so. Some of these businesses will, of course, be marginal both in size and quality, and will appeal more to smaller, individual buyers many of whom will have their eyes on rates – both interest and inflation.
The Bottom Line
There will always be buyers and sellers of businesses and the effects of the recent financial turmoil, though getting plenty of press, have been relatively modest.
People of a certain age realize that the current level of interest rates is, historically speaking, not high at all. It’s just that we’ve been spoiled by 4-5 years of historically low rates; levels that most financially literate individuals knew could not last forever. Buyers and sellers are adjusting to the “new” reality.
While this “new reality” will soon be no big deal, our bigger long-term concern is inflation which impacts everything from a product’s packaging and a shipper’s fuel expense to payroll. In fact, there’s nothing not impacted by inflation and if governments can’t get some control of spending, I suspect we’re in for bigger problems down the road.
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 jo*@Wo*******************.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.
Joe
Searching For…
A small, mid-Atlantic private equity group is seeking pest control business located east of the Mississippi River with a focus on the Carolinas, Virginia. Maryland and Tennessee. Their investment range is $500,000 – $5 million.
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 600 in the world. He can be reached at jo*@Wo*******************.com