This is Part 1 of a 3 Part series in which we explore bringing a business to market and offer a framework that owners can use to determine their optimal sale timing. Part 2 will cover personal reasons that compel owners to sell, and Part 3 will provide thoughts on economic trends and the impact of these trends on the odds that a sale process is completed.
2023 Was a Lesson in the Challenge of Forecasts
With 2023 officially in the rearview mirror, we leave behind a year of economic paradox. What began with economic uncertainty ended with financial market resilience, despite predictions to the contrary. At the onset of 2023, economic projections painted a picture of modest, or in some cases negative, growth. A December 2022 Bloomberg survey of economists placed a 70% chance of a U.S. recession in 2023, while many Wall Street strategists were calling for a down year in stocks.
Trends Were Troubling Heading Into 2023
It’s easy to understand why economists and analysts had a negative stance heading into 2023. In 2022, the Federal Reserve embarked on an aggressive rate hiking cycle, bringing the target Fed funds rate from 0.25% at the start of 2022 to 4.5% just 12 months later, the steepest rate hike since the 1980s. Generally, higher interest rates result in slower economic growth because the increased cost of borrowing negatively impacts demand for goods, services, capital projects, and investment, leading to a slowdown in earnings and production.
In the midst of the rapid increase in rates, 2022 ended with a heavily inverted yield curve, measured as the 10-year treasury rate minus the 2-year treasury rate. The December 2022 yield curve inversion was at its lowest (most negative) since 1981. Historically, yield curve inversion (near-term rates greater than long-term rates) has been a sign of impending negative economic outcomes and represents a deviation from the positive slope of a “normal” yield curve (near-term rates less than long-term rates). In the figure below, values below zero represent an inverted yield curve, and values above zero represent a normal, or positively sloped, yield curve. As the figure shows, December 2022’s inversion was a multi-decade low.
But The Economy Remained Resilient
Contrary to forecasts, 2023 unfolded with unexpected resilience. Economic growth outperformed projections, with real gross domestic product, a measure of goods and services produced within the U.S., growing at a 2.2% annualized rate in Q1 ‘23, 2.1% in Q2 ‘23, and a robust 4.9% in Q3 ‘23, per the Bureau of Economic Analysis (Q4 ‘23 data has yet to be released as of the publishing of this article). Market performance also exceeded expectations, with the S&P 500 ending the year up over 26%.
To highlight 2023’s buoyancy, not only did the economy and stock market demonstrate stronger than expected performance in the face of sustained high rates and an inverted yield curve, the year’s turbulence included three of the four largest bank failures in U.S. history (First Republic, Silicon Valley, and Signature Bank). According to the FDIC, the total assets of failed banks in 2023 were 47% greater than the total assets of failed banks in 2008. Yet again, a sign of trouble early in 2023 that failed to rile markets in a manner that analysts would have forecasted.
Why This Matters For Business Sales in 2024
So what does 2023’s performance have to do with selling a business in 2024? As we turn our focus from the unpredictable twists of 2023 to the year ahead, it’s clear that predicting market trends is a complex and uncertain endeavor, even for experts. The discrepancy between 2023’s forecasts and the actual economic outcomes serves as a stark reminder that the future is uncertain.
Cycle Timing is Hard - But Economic Trends Are Important for the Sale Process
Our exploration of whether 2024 is a good year for a business sale hinges not on a stock market or economic forecast, but on an assessment of factors unique to each industry, business, and business owner. To be clear, economic factors are an important input in the business sale process, and in Part 3 of this series we’ll share a framework for determining whether economic trends are in a seller’s favor, but we note that attempting to time economic cycles is not an exercise for the faint of heart (just ask the economists attempting to project 2023 performance). Thus, understanding an economic trend, but not predicting where the economy will go, will serve as an important input as we explore timing for the sale process.
Personal Factors Also Important for Sale Timing
Determining when to sell a business requires a review of personal and economic factors. Each business owner will have unique personal circumstances that dictate when they desire to take a business to market for sale. For instance, retirement, other entrepreneurial interests, or the desire to reduce day-to-day responsibility are a few personal reasons that compel owners to begin a sale process. On the economic factor front, as we touched on in the opening, market trends are rarely in the control of the owner, but understanding these factors is important for increasing the odds that a deal can be completed within the owner's desired timeframe and at an acceptable valuation. Economic factors often dictate whether buyers are interested in investing in a business or industry, and serve as key inputs during valuation exercises.
When To Be Cautious About Selling
Are there times an owner shouldn’t sell? This is a difficult question to answer given that personal circumstances sometimes force an owner to put a business up for sale, in which case the freedom to choose when to sell is not afforded to an owner. Per the reference to economic factors, if an owner is forced to sell during peak market conditions then the sale outcome may be acceptable, even advantageous. However, if forced to sell during a period of economic weakness, the outcome may leave an owner feeling as though the deal did not result in adequate compensation for the effort required to build the company and to offset the risk taken along the way.
Furthermore, a shrewd buyer may discern that a seller is distressed, whether by personal or economic circumstances, and could factor this into negotiations or valuation. Stated plainly, forced sellers have little negotiating leverage, and the results of a forced sale leave little opportunity for timing a sale such that it coincides with robust economic conditions. In the absence of favorable economic trends, valuations may suffer, or worse, a sale may never happen.
Selling After Periods of Abnormally High Growth
On the topic of trends and timing for a sale, owners may feel compelled to take a business to market if recent performance has been abnormally strong. For instance, if a company’s revenue growth or profit jumps due to a favorable project, or another one time event, a seller may view this as an opportune time to cash in. Importantly, buyers are reluctant to assign value to such performance pops unless a business can show that the jump will be sustained.
An example would be a water damage remediation business that’s growing in the mid-single digits per year, then suddenly realizes a 30% plus increase in annual revenue due to an active hurricane season. In the example revenue schedule below, project volume in the second and third quarters of 2022 suddenly jumps as demand for remediation work increases. While this is great for the business and its financial performance, it may be a trend that buyers approach with caution. Unless the business can show that the increased level of revenue represents a new trend and not a one-time event, buyers may discount the higher than normal growth in anticipation of a return to the 4% to 8% growth trend.
Selling When The Owner is Ready and the Business is Healthy - Be Prepared
The key takeaway is that owners will want to control the timing of a sale. Distressed sales due to circumstances such as poor business performance, declining physical health of the owner, or other outside factors, rarely result in outcomes that a seller would deem to be favorable. Preparation is a recurring theme among successful business sales, and is particularly applicable to timing a sale. It is important to understand the steps in the business sale process and to gradually take action to prepare a business for sale. This will best position the seller to run a controlled process and to time the sale process such that it occurs with the support of a favorable economic backdrop.
Up Next
In Part 2 we’ll dive into personal factors that determine when owners should sell, and will offer five common personal reasons that result in owners electing to pursue a business sale.
In Part 3 we’ll share a simple framework that sellers can use to assess the economic backdrop and to determine how company trends, industry trends, and broad economic trends may impact the sale process.
