If you follow the economic news, you may wonder how inflation may impact selling your small business. Does this mean waiting to see what happens? Or accelerating your plans to get out before things get worse?
A recent report from MetLife & the U.S. Chamber of Commerce found that 33% of small business owners report inflation as their biggest concern. As the cost of supplies and materials, borrowing, and labor increase, small business owners are faced with a decrease in profits, increasing prices, or cutting costs, including reducing staff.
Let’s look at some of the ways inflation could impact selling or exiting your small business.
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Any increase in costs can lead to lower margins and slower growth and reduce business valuations
Supply chain woes and other global crises have pushed up the costs of materials and supplies. As a result, small business owners are faced with difficult decisions, and 67% of small business owners report they have increased their prices already this year.
Others have had to reduce staff which hits small businesses with fewer than 50 employees especially hard. To stay competitive, small business owners must balance viability versus profitability, which often means that profits get squeezed. In turn, this may impact the calculated value of a business.
Most main street business valuations are based on Seller’s Discretionary Earnings, which uses the net profit as a primary input to calculate valuation (what your business is worth). When profits go down, valuations are impacted. Why is that?
The result of lower profit is less available cash to take out of the business and that is what a buyer is using to determine if they wish to acquire the business and how much they are willing to pay. The less cash they can take out as income or to reinvest in the business drives down the value of the business.
Therefore, knowing what your business is worth before you plan to sell is a good idea so you are not blindsided by the valuation and can take measures to increase profits (more on that later).
There is some good news if you plan to exit sooner versus later. Valuations use at least three years of profit and loss statements. So, suppose the cost of supplies, inventory, or other related operating expenses has increased in the past six months. In that case, those higher costs may be offset by the previous years with lower costs.
This means using three years of profits; the more time within those three years is amid higher inflation, the more significant the impact it can be on a business valuation. Of course, no one knows how long an inflationary period will last and how high it will go.
The interest rate on SBA Loans will go up, which may make it harder for buyers to obtain financing
When the government, the Federal Reserve, adjusts interest rates, the impact is far and wide. Loan interest rates vary for all types of loans, including home loans, car loans, and credit cards. Suppose a buyer is planning to get a Small Business Loan to complete the acquisition. In that case, inflation will impact the loan rate and potentially their ability to qualify for an SBA Loan.
Guidant Financial predicts rates to increase to over 6% in 2022, increasing the monthly repayment. If profits are already squeezed, an increase in the cost of serving a loan may deter some buyers. However, it is important to know that 65% of transactions are seller-financed. Therefore, seller-financing may be a more attractive option when both parties are motivated to make a deal happen.
A small business may be seen as a safer investment than the stock market or real estate
Over the past 10 years, the U.S. stock markets have experienced dramatic growth despite a dip during the pandemic in 2020. But, as we all know, 2022 has been a challenging year so far. As a result, many investors are seeking alternative investments, which may be good news for small business owners who want to sell their businesses.
For example, suppose you have been in business for five years or more and are profitable. In that case, you may attract investors who want an alternative to the public markets by putting their money into a more hands-on investment. A business that generates relatively predictable cash flow is appealing and even more so when compared with a period of market volatility.
What you can do to prepare to sell your business during a period of inflation
No doubt the past few years have been difficult. Just as the economy was emerging from the downturn due to the pandemic, inflation started to rise. But, remember, you are not alone; all aspects of the economy are impacted.
You can take some steps if you want to sell your business in the next 12 months.
- Reduce discretionary expenses. This is a good strategy anyway, especially now that operating costs and the cost of goods have increased.
- See if you can negotiate better terms on your biggest expenses. Offering to pay on a shorter term (15 days vs. 30, for example) may help or commit to ordering a set volume over time.
- Raise prices with transparency. Customers are feeling the pinch and are often expecting prices to increase. This is not an easy decision to make and carries some risk of reducing sales. Communicating the reason for the increase, and the amount, can help ease the blow.
Obviously, inflation is not within your control. However, you do have control over when you sell your business and how you prepare the business to appeal to prospective buyers. This may mean more than basic “belt-tightening” measures, so it is best to allow as much time as possible to create a plan and put it into place.
Do not discount the emotional impact the process and eventual transition will have on you and those close to you. This is a major life decision for most small business owners and requires a healthy mindset and planning under the best circumstances. Focus on what you can control and use resources like ExitGuide to help you navigate the process.