Selling a Business: The Impact of the Coronavirus
Aside from staying home or avoiding even modest crowds, people everywhere are reacting to this virus a little differently. A new phrase – “social distancing” – has been coined to describe the recommended distance that should be kept between individuals. But as serious as this may be, some people have taken things to extremes. For example, as social distancers go, the guy shown at left is in a class by himself.
In the United States, there has been an inexplicable run on toilet paper, of all things! I can understand stocking up on canned tuna and soups, but toilet paper?!? I’ve not yet heard the reasoning behind this trend but until I do, I’m be a bit worried that, should an outbreak of diarrhea befall the world, Americans will start stockpiling nasal spray!
The Possible Impact on the Sale of BusinessesIn a more serious vein, there has been fairly extensive reporting about the projected impact of this virus on real estate sales. Open houses have been cancelled. Both buying and selling traffic is down; fewer buyers are calling about homes that are for sale and fewer homeowners are calling realtors about selling. This, in spite of the lowest recorded home financing rates ever, at least in the U.S. Similarly, business brokers and business owners – no matter where you are – are going to be impacted by this virus, as well, and for many of the same reasons. People are hunkering down. There’s a discernible level of fear in the air. Here are some issues to consider
The Impact on Available CapitalBuyers of small and smaller mid-size businesses generally must have anywhere between 15% and 30% of the purchase price of a business to put into the deal. Buying a $2 million business will likely require about $500,000 in cash from the buyer. (The balance can usually be financed through some combination of an institutional lender and the seller.) Where do they get that money? I don’t know of anyone that keeps that kind of cash lying around. It’s invested somewhere. In our experience, buyers get that money from their investment and retirement accounts. We’ve found that, in the U.S., IRA and 401k accounts are the main source of a buyer’s cash. But stock markets around the world have cratered: down 30% in London, 33% in Paris, 33% in Frankfurt, 28% in Tokyo, 35% in Sydney and, as I write this early on 16 March, more than 25% in New York. Everyone’s individual financial statement is between 20% and 35% weaker than it was just weeks ago. On top of that, oil prices have fallen off a cliff – down nearly 50% from their highs just 90 days ago, helped in large part by the new feud between Russia and Saudi Arabia. This has impacted everything from Blue Chips like Exxon/Mobile (down more than 50% since the start of the year) to the sovereign wealth funds of Middle East nations. Normally, such a collapse in oil prices would boost airlines and other travel-related industries because it makes travel much cheaper. But nobody’s going anywhere! This morning, I received a notice from the International Business Brokers Association (IBBA) that this year’s annual convention, scheduled for April, has been cancelled. Companies in travel-related industries are getting clobbered. The result of this is that a good portion of the business buyers out there have significantly less cash to put into a deal. That will either sideline many of those buyers until the financial environment changes or change the size of the businesses they’ll consider. On the flip side (there’s always a silver lining), interest rates are now at their lowest levels in… well, maybe forever. Central banks are flooding the markets making capital cheap. Property refinancing – both commercial and residential – is expected to climb. Borrowing to acquire a profitable business – at the correct valuation! – should be relatively easy, once things settle down.
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The Impact on ValuationsAnd that brings me to the second big issue: business valuations There’s no telling how long this crisis – both viral and economic – will last but if there is anything less than a quick rebound, valuations will fall. Why? Because if revenue falls, earnings will fall. And buyers pay for earnings. If historical data says that buyers will pay 2.5 times the earnings of lower Middle Market wholesale businesses, such a business with $1 million in earnings will be valued at about $2.5 million. But if that business’ earnings abruptly fall to $300,000 – and stay around that level for a year of two – the value is going to be a lot closer to $750,000.
Timing and scale – both the duration and depth of the virus and the degree of damage to and recovery time of the economy – are important here. Prognosticators are everywhere and of the ones I pay attention to, most believe that the virus might, like the annual flu, be contained and gradually peter out over the next couple of months – but that the economic damage caused will be significant and long-lasting. This morning’s Wall Street Journal contained an essay by Andy Kessler about the possibility that this event means a new business era. But these many prognosticators also are nearly unanimous in their belief that the economy will suffer significant damage and take a long time – years – to recover. Granted, some of this pessimism is born of the fact that economies worldwide have been on a tear for longer than any other period in history and a pullback was overdue – some say LONG overdue. An “overdue” pullback combined with the impact this new virus is having – and will continue to have – on world economies is what is driving the current crisis.
“Buy When There’s Blood in the Streets”Baron Nathan Rothschild, an 18th-century British nobleman and member of the Rothschild banking family, is credited with saying that “the time to buy is when there’s blood in the streets.” There will certainly be buyers – some might say “vultures” – that will be swooping in to buy businesses at a steep discount. But many business owners may pull their business off the market for a while. This may be especially true of those that have worked out an exit strategy and know how much they need to walk away with. They’ll wait until their business’ value climbs to a level that will provide that target number. And some owners that have been considering selling may hold off – first, to let the dust settle and then to get their numbers back up to where they need to be for them to leave the closing table with the proceeds necessary to fund their planned – and now possibly delayed – retirement. Some current sellers, though the value of their business will have almost certainly decreased, may be unwilling to accept that fact and hope that a buyer with more money than sense will come along. If you’re a broker that represents any such sellers, the proverbial heart-to-heart chat is in order.
The Bottom LineOver the past three years, I’ve written regularly about the exuberant state of the acquisitions market; how it was a great time to sell; how much money was floating around looking for profitable businesses to buy; who the buyers were, etc. Absent this virus, economic fundamentals have been strong with little reason to expect any significant disruption. But the virus has changed the dynamic and, if Kessler’s correct, it may be moving us into a new business era. I don’t know what the future holds, particularly as we look out three to five years from now. But I can tell you this with certainty: nobody’s getting any younger. The Silver Tsunami – the number of Baby Boomer business owners – will continue to break along the shores of the business brokerage industry. Businesses will continue to sell. Buyers will always be with us. We’re cautioning our clients. There’s no need to panic. The stomach-turning drop in markets will end soon and we’ll return to some level of stability. It’s at that point that we’ll reassess the businesses that we’re representing. I suspect that, once the dust settles, the buying market will still be robust. After all, Boomers are still getting older and the desire to own ones own business will remain strong. Valuations and the availability of capital will, as they have been for centuries, still be the two pillars on which rest our market. Business will adjust accordingly.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want 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 profitable week! Joe
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