With increased interest rates, as well as other market headwinds such as inflation, come challenges for buyers that translate to challenges for sellers. Louis Plung & Co. Partner Tony Montanaro says such factors typically drive down the value of many businesses because the higher risk equals lower valuations.
Though this past year was a very slow year for deal making on a macro level, in the middle-market he says deals are still happening. There are, however, caveats.
He says deals have changed somewhat as a result of the current economic conditions. One issue is a push for lower valuations on the part of buyers because the higher interest rates create greater risk for leveraged deals. Also, as money becomes more expensive and lending has tightened, buyers are becoming more selective in the deals that they make. However, quality assets are still demanding premium prices, and there are still plenty of buyers out there for lower risk, better performing investments.
But, to get a deal done, he says there has been more extensive due diligence, both in the amount of time buyers are taking to complete their due diligence, as well as the extent and depth of due diligence they're doing.
"We're seeing a lot more inquiries related to any supply chain disruptions that have occurred over the last few years; and then basically quantifying that, identifying how that impacted the business, how the business reacted, and what the financial impact of that was," he says.
Similarly, with inflation, more companies have raised prices, and in many instances, it was the first time they've raised prices in four or five years. That's another area of scrutiny during diligence.
"So, quantifying that impact, the increasing prices versus historical — have they grown through adding customers, are they selling more product, or is their revenue increasing as a result of raising prices? So, definitely more work related to those factors than we've seen historically. Looking at profit margins, where they would maintain profit margins during these periods, are they are they able to pass an increase in supply costs to their customers so that they're able to maintain their profitability? And then, looking more towards historical growth. There's a lot of things here that basically from COVID on could have impacted a company's growth rates. So, one of the things we're looking to do is determine whether a company's historical profitability is able to be continued into the future. And with all this economic uncertainty, that is not always the easiest question to answer."
Montanaro talked more about the conditions in today's market and how they're impacting both buyers and sellers on the Smart Business Dealmakers Podcast.
