Part II in Our Series on Business Valuation – Market Conditions
Last month, we opened the discussion on how the value of your business is generally determined. This month, in Part II, we will delve into our series discussing specific value drivers you should consider when preparing to sell your business starting with market conditions.
When we meet with a prospective seller, we spend a great deal of time reviewing valuation drivers. As we navigate the sales process and prepare your business for sale, there are variables you can control and some you cannot. Market conditions and interest rates are important to consider, but they are not in your control. So, decisions often come down to timing and determining the pros and cons of the sale in the conditions that exist now and what we can reasonably anticipate over the next several months.
Understanding Market Conditions
Generally speaking, when people think of market conditions, they tend to think about the stock market. With the volatility of the stock market, it is difficult to determine what will happen next. When talking about small privately held businesses, it is not as easy as flipping on Fox Business or MSNBC or calling a stockbroker. The private company market is not that efficient or liquid. In evaluating market conditions in privately held businesses, you must do more research and stay focused on the big picture. Yes, you're looking at things such as the interest rate as well as the macroeconomy. Sometimes industry-related market conditions will factor in, but that’s an entirely different and distinct value driver that we will address as our topic next month. Nonetheless, one market condition on everyone’s minds lately is interest rates.
Interest Rates
Rising interest rates mean it's more costly to obtain capital. And so, debt exposure is going to erode your bottom line to some extent because it impacts businesses' free cash flow. You have to build that factor into your pro forma as you model the way a buyer will buy your business. Interest rates can also impact other types of instruments in the market. Some small business sales that are Main Street transactions involved a seller financing component. What that means on a seller promissory note is that you may ask the seller to lend some money to buy the business. Sometimes that's 5% of the deal. Sometimes it's 80% of the deal. Right now, with rates going up, sellers can expect better returns on their loans when they sell their businesses.
Here is another way to consider the impact of higher interest rates from a seller’s point of view. If you reinvest closing proceeds with an interest component, your monetization of the sale now can take advantage of better returns at substantially less risk (than owning the business). Then, if you invest your closing proceeds at higher interest rates, and you seller-finance a portion of the sale, you could be coming out much better over the long term than perhaps only six months ago. If the seller note repayments go as planned, which they typically do, (if structured correctly, the seller note default risk is significantly lower than you might expect) you as a seller might be surprised that the timing of a sale is actually still favorable. Don’t fall into the trap of ‘doom and gloom’ news media. Stay level-headed and crunch the numbers with your advisors.
Interest Rates and Buyers
While we are in a strange time economically, over the long term, interest rates still aren't that expensive. The cost of debt is cheaper than the cost of equity, so there are a lot of reasons why small business transactions are going to see a healthy number of deals to go through over the next year or so.
Do Not Rise and Fall with Interest Rates
As buyers, one thing that is important to understand is that interest rates should not make or break the deal. While rates and other variables can impact your bottom line, the impact may not be as big as some other major event that can happen in this business overnight. So, it is important to know that while higher rates don’t necessarily help the valuations from a seller’s perspective, if a buyer is looking for a certain business and it comes across the table at a reasonable price, it can still be a great opportunity regardless of the short-term rate conditions. Additionally, buyers can later refinance or pay it off. The business should be able to pay the debt service with a healthy cushion (margin of safety) or you should not be buying it, right?
Supply and Demand
Supply and Demand is another component that is not within your control. Right now, the supply of quality businesses on the market is still historically low. If you are looking to time the market as a business owner, you really need to be considering selling sooner rather than later before the vast majority of the Baby Boomers decide to put their businesses up for sale. But as far as competitive forces and scarcity of inventory, market conditions are still really good for a seller.
Coping with Unexpected Events
Coming off a very impactful pandemic and a volatile social and political climate, Transworld has helped people navigate an unpredictable world environment. While market conditions and interest rates always lead the conversation, the pandemic introduced variables that changed the nature of businesses overnight. We have been able to help a lot of businesses get out of situations that were tough, and some businesses that thrived during COVID-19 found that it was a good time to sell. Overall, the trend of a lot of these small businesses that had good foundations is that the market, as we got out of the pandemic, came back and profits actually increased.
Transworld’s Role in Navigating Market Conditions with a Seller
As experienced business advisors, one of the first things we do with a new seller is to set realistic expectations of the selling process and outcome. As things change economically or situationally, we walk you through the deal process, adapting as necessary, and keeping you informed of prevailing lender requirements, among many other things to help you optimize the sale price in the current market conditions. We can help clients navigate solutions to any accommodation the marketplace may require by helping you understand the right levers available and when to pull them.
Frequently, our role can be to make sure that the two parties are a good fit and both sides understand each other’s positions (using us as a buffer) without letting tough negotiations stifle a really great deal for both sides. We help you keep emotions out of the process to make the best decisions possible under the circumstances and our experience goes a long way to get the deal across the finish line.
About Transworld Business Advisors of the Gulf Coast
Transworld Business Advisors of the Gulf Coast covers the northern Gulf Coast along the I-10 & I-65 corridors with special emphasis in Mobile, AL to New Orleans, LA. We strive to be the top business brokerage firm in the area and leverage our extensive experiences and our international Transworld platform to run confidential and competitive business sales processes. We help entrepreneurs to buy a business or sell a business, with a focus on helping family-owned and closely held businesses with their strategic plans for the future. Transworld offers a wide range of advisory services to the northern Gulf Coast Region, including Alabama, Mississippi, Louisiana and the Florida panhandle, that are tailored to fit your business needs, whether you’re buying, selling, preparing to sell, or franchising.
If you are ready to sell, or you would like assistance getting your business ready to sell, reach out today at [email protected].
