After five consecutive quarters of year-over-year growth, small business acquisition activity has slowed, according to BizBuySell’s Insight Report, which tracks and analyzes U.S. business-for-sale transactions and sentiment from business owners, buyers, and brokers. The number of closed deals reported in Q3 dropped 2% year-over-year to 2,237, and was 4.5% lower than the number reported in Q2.
More significant, small business asking prices in Q3 dropped 13% year-over-year and sale prices dropped 14%, respectively, correlating with weaker financials. Median revenue of sold businesses in Q3 declined 11% from Q2 and 7% from the previous year, while median cash flow in Q3 declined 3% from Q2 and 4% from the previous year, The average cash flow multiple declined 3.5% year-over-year to 2.5 from 2.9.
These declining numbers suggest that sellers are reducing prices to accommodate buyers who are facing rising interest rates and higher acquisition costs. This is compounded by rising costs impacting seller’s discretionary earnings.
“Transaction costs are increasing due to higher interest rates and the fees associated to obtaining a small business loan. Buyers are calculating that increased cost into their decision making and offer as they expect a certain ROI for their capital, time, and risk,” said Dustin Zeher, owner of Horizon Business Brokers in Virginia. “Higher costs and lower returns will negatively impact the cash flow multiple and value of the business as buyers try to maintain a modest return for their investment or their time and capital, and risk of capital.”
Still, some industry sectors, saw steady demand. The number of restaurants sold grew 14% year-over-year while service business grew a modest 4%. Moreover, the median days on the market dropped to 169 days, down from 170 days in Q2 and 181 days in Q1 of 2022. This could be attributed to shorter closing times as buyers look to lock-in lower interest rates amid the Fed’s fight against inflation.
Small Business Owner Confidence Fades Amid Rising Costs and Recession Fears
Confidence among small business owners dropped to a score of 46 in 2022, down from 57 in 2021, according to BizBuySell’s Business for Sale Confidence Index, which measures the sentiments of over 3,000 business owners and buyers. A score of 46 falls within a point of 2020’s record low of 45, when owners were acutely concerned over the pandemic, a first-time drop below 52.
As was the case in 2020, owner concern is centered on business value. In fact, the majority (59%) attribute economic uncertainty as the top factor for decreased business values. Of those planning on selling their business, 79% are concerned about entering a recession within the next year, and over a third (35%) say this would motivate them to sell their business sooner. However, (54%) would not discount their sale price due to recession concerns.
Inflation and rising interest rates are two major concerns affecting owners’ confidence. In fact, 83% say they are experiencing higher costs, with 79% saying inflation is not easing.
“All costs seem to have been impacted negatively by the pandemic. Transportation and delivery issues. Labor shortages. Price gouging. Public uncertainty, even fear,” said Melanie L. Miller, owner of Muy Bella, LLC in Florida.
Plus, most business owners (58%) say the labor market is not improving while many (42%) say supply chain issues are not improving either.
Miller adds the following unfortunate example of real-world pressures on labor, “You can become a licensed and certified bartender in one week. Whereas the hair salon industry cannot hire eager grads because they don’t want to go to the more extensive training to get licensed. I know a local salon that fought until the bitter end – reduced her “station rentals” in half, offered a $5k signing bonus with a 1-year commitment. I am not sure what else, but she ended up folding – after 14 years in the same location, great service, etc.”
Furthermore, rising interest rates are making it increasingly difficult for owners to source new capital to cover costs and maintain cash flow. With the pressure of rising costs, many are left in the position of paying higher rates to cover debts, putting further strain on profitability.
Business Buyers More Optimistic About Today’s Market, Expect Sellers to Discount Prices
In contrast, small business buyer confidence has risen to a score of 54 in 2022, up from 48 in 2021, after a high of 60 in 2020 when buyers found opportunities, such as thriving essential businesses in unique pandemic conditions. In today’s market (73%) are confident they can buy a business for an acceptable price, with 53% citing economic uncertainty as the top factor. In addition, most buyers (52%) believe economic uncertainty is a reason for a discounted purchase price.
However optimistic, 37% of buyers feel they would have been better off purchasing a business last year. With rising interest rates and the high cost of acquisitions, 41% feeling it may be difficult to make a purchase. Business values are another issue, with 42% attributing owners setting unrealistic prices as the top factor to less acceptable prices. Most (48%) believe they would get a better deal if they waited a year. Similar to the housing market, this leaves buyers in a dilemma of waiting for a better sale price verses paying the additional costs associated with higher interest rates.
Buyer Demand for Restaurants Up as Dining Out Increases. Other Retailers Sees Fewer Deals
Restaurant demand has bounced back since the depths of the pandemic, with closed transactions up 14% year-over-year. As both indoor and outdoor dining becomes increasingly popular, buyers are seeking new opportunities, likely in high trafficked locations. Restaurants sold for a median sale price of $209,500, up 5% over the previous year, yet 30% below the median sale price of all Q3 transactions. This price differential is common as restaurants tend to be smaller and especially the quick-serve establishments which have been an increasingly popular acquisition since the pandemic began.
“We can definitely show, with data to support, that our buyer registrations for expressing interest in acquiring or leasing a restaurant is up by 9.5% from Q2 and gaining 5% back from Q2 over a Q1 loss. In terms of sellers, we have had 12% growth in the number of seller registrations from Q2 and 29% growth from Q1,” said Steve Zimmerman, President, CEO, Principal Broker & Founder of Restaurant Realty Company in California.
In contrast, other retail businesses saw less buyer interest, with closed transactions down 22% over the previous quarter and down 10% year-over-year. Furthermore, these retail businesses reported a 21% drop in median revenue and a 6% decrease in cash flow in Q3 versus last quarter. Compared to restaurants, buyers paid more for retail businesses, which sold for a median price of $275,000, yet this is 7% less than the previous quarter and 2% less than a year ago.
Service sector acquisitions improved 3% over the previous year, but down 3% over the previous quarter. Median revenue for service businesses was down 8% over the previous quarter and flat over the previous year, while median cash flow was down 6% over the previous quarter and 5% over the previous year. Nonetheless, median sale prices remained flat at $299,000, but with sellers asking 14% less than in Q2 and 13% less than the same time in 2021. While service businesses have been in higher demand since the pandemic, these numbers could indicate a return toward pre-pandemic proportions.
Rate Hikes and Inflation Continue to Impact Business for Sale Market
While economic volatility headlines news as the Federal Reserve is expected to increase rates by at least 125 basis points before the year end, some signs of relief exist. In fact, according to a CoStar report, multifamily rent growth has begun cooling across the country. This is a critical trend as housing makes up 30% of overall inflation and 40% of core CPI and is just one example of how lagging indicators create challenges for forward looking policies. It’s also not long ago that inflation was considered transitory, a reminder of how quickly policy can change.
While these macroeconomic trends are worth considering, business owners must also keep a close eye out for growth opportunities while at the same time managing risk. The risk has long been expected to drive a wave of Baby Boomer sellers into the market. While we have yet to truly see that grey tsunami swell, the clouds are brewing. According to surveyed owners, almost half (48%) are selling due to retirement.
“The current trend we are seeing is more sellers looking to cash out. Owners who survived COVID and have been able to strengthen their businesses are tired, and they are ready to move on. Employment is still an issue, as many businesses are still having a hard time recruiting staff. Although the recent jobs report indicated a slowdown, unemployment is still very low,” said Diane Hartz Warsoff CEO/Owner of Transworld Business Advisors of Utah County.
Interestingly, just 12% of owners say economic uncertainty is influencing their decision to sell which speaks to the personal nature of selling one’s business, and this is where the true risk lies for those not planning ahead. While retirement is motivation for an eventual exit, it’s easy to put off action. This is why among the top reasons for selling are what Sheila Spangler, Certified Business Intermediary at Murphy Business in Idaho, refers to as the Dismal D’s.
“The Dismal D’s are declining sales, dissention among owners, disinterest, disaster, distraction, debt, divorce, disease, disability, and death, and any of these puts the seller at a disadvantage for price and deal structure,” according to Spangler.
Owners in today’s market should at minimum speak with a broker about their exit strategy, so they are ready to exit on top or have a plan in event of the distress.
“There are businesses that were started in the mid-2010s that are going to be selling soon, and some that were started just before covid will be selling as well. The value is based on their performance and differentiation. For those operating and not looking to exit, the same applies to determining their survival for the next 10 years,” said D.A. Wells, owner of Kinsmen Capital Group LLC in Florida.
For buyers, as with the pandemic shutdowns, tremendous opportunity exists to secure a profitable business and perhaps at a discounted rate due to increased costs compressing seller’s discretionary earnings, the foundation of business valuations. The core challenge for those looking to buy a business will be securing financing which becomes more expensive with each federal rate hike. In fact, 74% of buyers say higher rates are impacting their ability finance a purchase, almost half indicating a great impact.
For this reason, owners looking to sell now should consider offering seller financing to help close the deal. In fact, 56% of buyers surveyed expect the seller to finance the deal, slightly more than the 55% planning to use an SBA loan. Seller financing also offers buyers the benefit of keeping the previous owner involved to ensure continued performance.
“I have a closing the end of October affected by rising interest rates. The buyer planned to use a HELOC to purchase the business, and after shopping rates, the buyer insisted on a Seller Carry Note. The motivated seller is carrying 60% of the sale price,” said Larry Goldstein of First Choice Business Brokers in Nevada.
Zeher adds, “seller financing allows owners to sell their business for ‘market or more’ while also earning interest by potentially collateralizing part of the loan against assets of the business and/or the buyer/borrowers personal assets as a bank would. If the seller is able to wait and take a risk, maybe so much so as the buyer is taking the risk to purchase their business, the seller could really make out in the end. Or they can take a lower price and get all their money now.”
With all the uncertainty in the world today, the best advice is to be prepared. This is especially true when considering the average time to buy or sell a business is 6-months to a year. Again, a lot can change in that time frame, and with it many opportunities for those opportunistic.
“I believe our economy will see a huge increase in the small business market in 2023. It will be an exciting time to own, sell, or buy a small business. The economic drudgery of COVID and post-COVID is going to rebound and a new sense of optimism and community care for small businesses will grow,” said Laura Billimack, owner of The Pottery Place in Illinois.
About the BizBuySell Insight Report
The BizBuySell Insight Report is a nationally-recognized economic indicator that tracks the health of the U.S. small business economy. Each quarter, BizBuySell analyzes sales and listing prices of small businesses across the United States based on approximately 50,000 businesses for sale and those recently sold, reporting changes in closed transaction rates, valuation multiples and other economic indicators for the small business transaction market. Closed transactions are reported to BizBuySell.com on a voluntary basis by business brokers nationwide. Each report includes real small business data on over 70 major U.S. markets and across 65 small business industries.