The first half of 2022 has come and gone and we’ve got data to share with you and a market update to show you what we’ve learned from it.
Many transformative events have taken place over the past six months. We saw the return of COVID, a war on foreign soil, an energy crisis, an ever-tightening housing market, a labor shortage coupled with increases in minimum wage, instability in the supply chain, a historic rise in inflation, and the decision by the Federal Reserve Bank to increase interest rates at a historically record breaking percentage. During any other time, any one of these events on their own would have caused a big shake-up in our economy. Together, all of these events created an exponentially complicated and unprecedented level of uncertainty for business owners and investors.
Let’s examine how Q1 & Q2 2022 business sales transactions performed.
According to IBBA’s (International Business Broker’s Association) 2022 Q1’s Market Pulse report, brokers reported that labor shortages had the biggest impact on deal-making in the first quarter of 2022. 68% say it had a dampening effect on Main Street and lower middle market M&A. And of those 68%, 5% claimed that issues caused by the labor shortage directly resulted in the failure of deals that were otherwise set to close.
More than half of brokers (58%) reported that supply chain issues were having a negative impact on the market value of businesses, and 15% said that the Russia-Ukraine conflict had done much to hurt transactional activity. Over half of the brokers surveyed shared the belief that a recession was somewhat likely in the near future.
So how about the good news?
However, at the same time the US has a historical level of cash reserves when taking a combined look at the country’s Corporate Business balance sheets and consumers’ bank accounts.
Corporate balance sheets are generally strong with excess cash ready for the next wise investment opportunity. The general consumer population overall was able to save up during the continued COVID lockdowns which encouraged a reduction in unnecessary spending and a culture of frugality in anticipation of upcoming difficult times.
According to Federal Reserve data, at the end of March 2022, households had $18.5 trillion tucked away in deposits, savings and money-market accounts; more than $5 trillion above what they had heading into the pandemic. Cash reserves rose across income groups, from low-income accounts to the highest-income accounts.
The Federal Reserve Bank of New York reported that many Americans used federally issued relief checks to pay down debt. Household financial obligations, including rent, mortgage payments, car leases, homeowner’s insurance and other recurring bills, accounted for 14% of their disposable income in the first quarter, according to the Fed, which is a historically low number. In contrast, heading into the recession of 2007, that number was about 17% to 18%. The 3%- to 4%-point difference between then and now adds up to a lot – roughly $550 billion to $725 billion of annual income collectively that households can save or spend.
The Federal Reserve Bank increased the fed rate by 75 basis points in June. This interest rate hike was the Federal Reserve Bank’s tool to combat inflation. Whether this decision is achieving its goal is still debatable, but we know for certain that business investors are feeling the squeeze when it comes to the higher cost of investment.
To Buy or Sell a Biz?
According to BizBuySell.com (the leading small business listing site in the US and Canada), the number of small business acquisitions slipped by 3% in Q2 of 2022. But, the year-over-year amount of money invested in business acquisitions still grew by 14% which suggests a strong market and effective navigation through economic headwinds. More pronounced, the median sale price dropped 9% below the previous quarter from $345,000 to $315,000, which is still only 2% below last year’s $320,000. The drop in sales prices appears to be linked to the requirement for more realistic prices, perhaps due to inflation’s effects on cost of goods, labor and real estate, the requirement to balance high price tags caused by the sudden and steep rise in interest rates, and other recession concerns.
Market performance continues to match and, in many cases, outperform pre-pandemic levels. Essentially, it’s not that business sales regressed but rather slowed in momentum toward growth.
Compared to Q2 2019, businesses sold at a median price 17% higher and possessed stronger financials, with median revenue 16% higher, and median cashflow 15% higher, respectively, according to BizBuySell.com.
Multiples dipped as well, with average revenue and cashflow multiples down 6% and 3% respectively vs last quarter; and down 6% and 1% compared to last year. This indicates that sellers are receiving lower offers to accommodate buyers. As interest rates increase, many lenders are conducting stress tests on the business cash flow as part of their approval process. As a result, lenders may increase the down payment required in order to reduce debt service payments – which will squeeze a buyer’s liquidity. So, even though the data shows an increased cash balance in investors’ accounts, inflation and the interest rate hike are eating away some of that liquidity.
The Bottom Line
Despite the dip in Q2 transactions from the first quarter, the market rebound remains intact with acquisitions up 58% since activity stalled in 2020. That said, current economic conditions are likely to present a short-term speed bump in the road to a complete recovery. This is particularly true for buyers having to navigate more costly financing.
Ultimately there is still a backlogged outflow of retiring Baby Boomers who want to sell their businesses. So, if you are one of them and still want to plan your exit, you will need to be more creative with making a deal with a buyer. As an example, any owner who can offer seller financing to supplement a lower loan amount from SBA will likely find themselves in a more favorable position in today’s market.
For more tips and advice on how to situate your business for the current and upcoming markets, contact me at our office.