The first, and most important, point is that my crystal ball is broken. I hate to disappoint you, but I do not know what is going to happen to the business sales market in 2024.
We can, however, discuss the downstream effects of market conditions that might result from widely discussed policy priorities (read: controlling inflation).
Economic conditions (or, more accurately, the perception of economic conditions) have significant effect on any market. If buyers think that the economy is strong, there will likely be a greater appetite for risk taking (as if working at a traditional job is not risky, but I digress), leading to more activity in the market; more inquiries on business listings, unsolicited emails and calls from individuals or equity groups looking to buy going concerns.
The effect of a good economy on sellers is less clear, in my opinion. If times are good, a seller might say to himself, “Why would I ever sell my business? I’m making lots money and I have a good team.” (As an aside, it is precisely this moment that they should sell their business. People who buy businesses want to make lots of money and have good teams too. They’ll pay more for that).
However, if buyers and sellers think the economy is weak, everything slows down; buyers are more cautious (or forced to be by their lenders), and their equity sources are more constrained. Sellers are always concerned about the economy and the effect it has on their business anyway, but the owner of a good business (one that is profitable and leverages his or her time) will think long and hard before listing their business for sale in a down economy for fear of the sale price being suppressed by market conditions. We saw this during COVID, many prospective sellers chose to withdraw their business from the listing/marketing process rather than advertise it in such a market.
This certainly is not a prediction as we are seeing the effects of higher interest rates in real time. The real question is if rates will continue to rise?
We have heard from several sources close to financial markets that we should expect another quarter point increase in the prime rate in December of this year (I don’t know when this will be published or when you’re reading it, so maybe it already happened?), so we can expect our SBA loan rates to increase again (SBA loan rates are typically a “Prime Rate + X%”). We may start seeing rate reductions in 2024, but how much is anyone’s guess. If policy makers main concern is controlling inflation, rate reductions will be gradual.
So, what does this mean for those considering buying or selling a business in 2024? Well, if we build a “prospectus” for a business listing that models what a transaction might look like for a potential buyer (given a certain set of reasonable assumptions), we will see that what constitutes an “acceptable” price for a business, (one that offers an acceptable rate of return after debt service) is significantly different at a 9.25% (or higher) interest rate vs 7%, even if the business continues to perform.
Bottom line, if lending rates continue to stay elevated, they will suppress prices for business sold with bank financing; the alternative for sellers (and our next point) is to become more creative and take on more of the risk.
Flexible Deal Structures
As a business seller, if a bank is unwilling to finance the transaction at your desired price, are you? While The Liberty Group of Nevada has, (over the last three years or so) had a great deal of success matching Buyers with SBA Bankers to help get deals financed, historically our office has seen many, many businesses change hands with seller financing, (about 80% of the transactions we brokered).
While everyone has heard a story where a buyer “Ran the business into the ground” and the seller “Got the business back”; I would keep in mind a few factors:
Bad news travels fast consumers who have a bad experience will tell everyone they had a bad experience. The unfortunate seller who carried a note and ended up getting stiffed for the money he was owed and ended up taking over a wrecked business is going to tell everyone he knows and likely write a book about his experience. As a species we are wired to prioritize information about things that will hurt us; so many of us naturally respond to the idea of a seller note in the same manner that we respond to the idea of a snake (some of them are dangerous so we should just treat them all as dangerous and we won’t have anything to worry about). I do not have statistics about the number of seller financed deals where the buyer stops paying, but in our experience, it is an exceedingly small percentage.
Business sellers forget to act like a bank — What do I mean by this? Well, banks are very, very good at what they do (storing, lending, and retrieving money with interest). What does a bank do when it is considering a loan to purchase a business? They ask a lot of questions: What is the buyer’s experience? Do they have transferrable skills? Understand that these are the skills for running the business, not necessarily delivering the work. In other words, an amazingly safe, efficient, intelligent, and disciplined truck driver is not necessarily qualified to run an entire trucking company. They may be, but do they understand HR, finance, maintenance intervals, dispatch, depreciation? Perhaps. Or he can learn it, or he can engage resources to help him, but we cannot assume that (even an extraordinary) technician can run the business.
Has the buyer been able to save money for a significant down payment? Where did the money come from? Why would the seller give up control of this tremendous asset (likely the most valuable asset in his portfolio) without getting a significant down payment? First, it proves that the buyer has the capacity to earn and save, but it also provides the Seller some benefit for taking on the risk of carrying a note.
Is the buyer a good credit risk? You can ask prospective buyers for their credit report; do they care about paying their bills?
Were the security agreements written and recorded? Was the financing secured by the buyer’s assets? This serves a couple purposes: A) It proves the buyer has the maturity and capacity to accumulate assets (see 2b and 2c above), and B) The seller has recourse if the buyer defaults. While we can never eliminate risk (banks sometimes make bad loans too), but the steps above (along with professional advice from an attorney, an accountant and even a Business Intermediary, risk can be mitigated.
Understand the market – A few years ago, when bank rates were very low, seller notes would typically be a point or so higher than the bank note to compensate the Seller for the inconvenience. Now, we are seeing transactions where the Seller carry note is lower than the bank rates just to make the deal pencil, so the Buyer has sufficient cash flow to keep the lights on and grow.
There can be some real benefits to seller financing: sellers should talk to their accountant or CPA about potential tax benefits of being paid on a note, over time, vs getting paid in a lump sum.
Any market must change to match conditions, regardless of how those conditions came about (it does not matter if the conditions came about due to a global pandemic or the policy responses to it; the market we’re in is the market we have. Just remember to vote). If the economy is perceived as weak or interest rates are high (or both) the structure of transactions, business or otherwise, will necessarily change.
While it will be different from what we’ve grown used to over the last several years, it isn’t anything new and business will continue to get done.
Stewart Guthrie, owner of The Liberty Group of Nevada, is a seasoned entrepreneur with more than two decades of experience in various industries. Guthrie served as a U.S. Marine.
See full article here.