27 Feb The “Triple Whammy Affect” on Listing & Selling Small Businesses (Part 1 of 2)
Whammy Number One: Valuations: A recent report from Business Valuation Resources of the 4Q 2013 Pratt’s Stats Private Deal Update reports the following pricing/valuation multiples of EBITDA used on sales made by business brokers, of businesses that sold for under $1,000,000:
2013 = 2.40
2012 = 2.36
2011 = 2.50
2010 = 2.34
2009 = 2.35
2008 = 2.58
2007 = 3.73
2006 = 4.15
2005 = 4.05
Obviously, a small business with EBITDA of $100,000 would have perhaps sold for $405,000 in “the good old days”, pre-recession, and a business with the same EBITDA, with the same assets, the same potential, etc., would likely have only sold for $240,000 in 2013. Most business brokers have had a much harder time finding listings that are priced in a range that buyers will pay in recent years, as many sellers don’t like the current multiples/pricing. Much of that challenge is because many business owners expect to receive multiples of EBITDA that simply are not happening, to the degree they did pre-recession. So, the seller refuses to list. Some brokers list the business anyway, at an “out of the market” price, “hoping for a miracle”, thereby inevitably lowering the broker’s “closing ratio’s” as fewer overpriced listings sell than listings priced within buyer expectations.
Whammy Number Two: EBITDA: Another reality that we’ve seen is that the typical small businesses we consider listing is throwing off less EBITDA today than the same business, even if with the same amount of sales, probably generated prior to the recent recession. This phenomenon is due to a variety of reasons, including:
*Many small businesses have experienced lower sales in recent downturn years, necessitating some of them to price their products/services to their customers more competitively today than in pre-recession years, to maintain market share (or lose as little market share as possible), thereby lowering their gross profits, thereby lowering their “bottom line” (EBITDA).
*Many businesses have experienced higher costs, for cost of goods, labor, facilities costs, etc., in recent years, but have been unable to offset those increases with higher prices charged to their customers, due to the struggle to maintain sales. In healthier economic times, businesses have traditionally been able to simply raise customer prices when costs go up, with rare exception, since their competitors, too, would be making the same adjustments. But, in this recession, with many businesses suffering from falling sales, and with the recovery forecasts being generally fairly positive and up-beat, but very conservative (few forecasters say the economy is likely to grow more than 2% to 3% for the next few years), raising customer prices has been too scary for most businesses to consider. So, instead, many businesses have absorbed their higher costs, again, lowering their typical average “bottom line” EBITDA.
Lower EBITDA, times any multiple, means the seller is likely to be asked to sell the business for less than they could have sold it for when their annual EBITDA was higher, thereby making the seller disappointed with the prospective sale price, thereby inhibiting their willingness to list at current market supported prices.
Whammy Number Three: Tight Financing: Especially in arranging small business acquisitions loans, today’s lenders have changed the criteria, “big time” over the last 5 to 6 years, almost everywhere in the USA. Yes, we still find willing lenders for quality deals. But, the down payments most buyers are required to contribute (even for high quality “no brainer” deals) has risen from typically under 20% (of the total “acquisition project cost”) prior to this recession, to buyer down payments of 25% to 33 1/3% required today…And, a 25% to 33 1/3% down payment is the requirement from the “best”, most aggressive lenders (Preferred SBA lenders). Most banks (most of whom are not aggressive small business acquisitions lenders, and/or who are primarily “fully collateralized”, non-SBA affiliated lenders) now commonly require the buyer to invest 50% or more of the acquisition as a down payment, if those more conservative banks will consider a small business acquisition loan at all. Even with seller financing present for part of the deal, most lenders still require higher buyer down payment investments today than in pre-recession years, and more supplemental collateral from the buyer’s personal assets.
All this is today’s financing reality, plus the fact that the Fed has raised the capital retention requirements of all banks in recent years, which means most banks have had to retain more of their available resources, reducing the resources available for them to lend. Ironically, interest rates are the lowest in decades, making this a great time for a buyer to borrow money to buy a business. But, with loans harder to qualify for, only the most qualified buyers/borrowers can take advantage of the low rates, leaving “out of the game” today many buyers who may have qualified in pre-recession years. Brokers, then, have to “throw more buyers at a listing” today than we had to introduce to the typical listing pre-recession to get it sold.
In next Tuesday’s post Bill will show how recognizing these “Triple Whammy” truths/challenges helps business brokers AND he will share what he has found to be effective in his own agency.
