Are you adjusting your approach for macro risk?
May 06, 2024
by a searcher from The University of Chicago - Booth School of Business in Santa Cruz, CA, USA
I've observed...
(1) Most if not all my deals under investigation have TTM < 2023 (SDE & Revenue)
(2) Sellers trading on COVID bump income still - reset still in progress
(3) Continued declines in small business confidence (lowest in 11 years)
(4) Interest rates not improving
(5) Election year with unclear impact
Are you guys seeing this too? Searchers - are you adjusting your approach?
Not sure if I'm just overly bearish today, but I can't shake the feeling it's a transition period and buyer's going to be left holding the (expensive, PG'ed) bag. I can envision plenty of ways to mitigate, and maybe even deals to be had, but I imagine seller expectations will lag the market reality. What am I missing?
in London, UK
Another theme to add to the mix is the macro changes in the ecosystem, including the loss of nature and climate change.
A recent report came out explaining the impact of nature degradation could cause a loss of 12% of the UK's GDP (https://www.greenfinanceinstitute.com/gfihive/insights/assessing-the-materiality-of-nature-related-financial-risks-for-the-uk/).
We're focusing massively on this with our long term decisions since nature and the climate won't get better on their own, and increasingly strong measures are being put in place to try to make sure it does get better - but there are many businesses which suffer as a result. Just a case of finding the ones that are positioned, or can pivot, well to play into this story.
I've been involved with some sustainable transition plans, and they can be quite transformative. My favourite has to be the oil and gas pipeline installation company that pivoted to cleaning ships so they use less oil and gas. All while making more money. If an oil and gas company can develop a robust plan to decrease their long term sustainability risk, then any company can - so it's not something to fear, but rather to be prepared for.
I'd say there is real potential for a strong investment thesis to be based on this transition. This would be where there is a core technology or process in a business which is unsustainable and it begins to challenge the viability of the business model (if for example, additional carbon taxes are implemented, or stronger regulation is enforced), which will result in a drop in their multiple. Following this, someone with a sustainable solution (ideally a nature-based solution) will come along and buy the business and help it convert. I think we'll see this play into the long term baby boomer trend, as this kind of problem requires a totally new skill set (often one which depends on technology and data to solve it efficiently) which will require totally different ways of working. It could quite easily be the final push a baby boomer owner needs to decide to sell their business. Too much complexity, too much uncertainty, too much risk.
Then comes along the lucky searcher, that finds a business which is unsustainable and buys it for a deep discount and they turn the risk to an opportunity by transitioning the practices.
The 'bring a business online' thesis is one that's been around for a while and I think we'll start seeing a new one in years to come - 'make the machine green'.
For anyone interested in looking into this more, a few links:
For seeing what may be required in the not-so-distant future in terms of sustainability reporting (think the same type of necessity and financial reports, but around sustainability), then you can look at the International Sustainability Standards Board's work here: https://www.ifrs.org/issued-standards/ifrs-sustainability-standards-navigator/. These are expected to be the global gold standard for sustainability standards moving forward. They also talk about the sustainability opportunities, not just risks - which is exactly my point around finding opportunities in these apparent dark spots.
There is a high likelihood as well that the 'Taskforce for Nature-related Financial Disclosures' will be integrated into the ISSB as well, which will mean additional disclosures will be required related to nature. More details here: https://tnfd.global/tnfd-publications/
Finally, to end this long post, the overarching principle behind my discussion is that doom and gloom is only a perspective one selects. It is possible to pick a different perspective, and see the opportunities for generosity which the current circumstances provide. One can even see a complex situation as a gift, the gift of a chance to express kindness, generosity, compassion, and joy to those around.
Besides that just being a nice way to live (as it just feels good to be generous), it also means you don't shut down your brain by letting cortisol stress you out as creativity, patience, and memory go out the window then.
Happy to talk more about this - reach out or comment if you've got questions!
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
As it relates to what we are seeing with current financial reporting, I can tell you in general roughly 50% of the businesses we are seeing have lower revenues and/or profits in 2023 from###-###-#### It appears the bounce back from 2022 was stronger for many companies and they are back to dealing with a more normalized business flow going forward. We are seeing many of these businesses with early revenues in the first quarter of 2024 tracking roughly with 2023 revenues. A few are down as well in the first quarter though. However, the other 50% of businesses we are looking at had revenue and/or profit growth in###-###-#### So the market is definitely not consistent.
There are some serious market headwinds. Inflation is still an issue, which is keeping interest rates high. Unemployment has spiked up, although this could be a benefit to many small businesses where they might be able to start to pay less for talent which has not been the case the last several years. Consumer debt is at all time highs. We are in a crazy election year which is going to provide plenty of distractions. War continues to rage in the Middle East and Europe, which impacts all sorts of products and costs. Although all of these items pose risk, they also create opportunity. There is also an opportunity cost in delaying to move forward with a purchase due to market trends.
I always recommend you look at the history of a company's financials going back more than 3 years. Although Banks and lenders only underwrite going back three years, you can go back 5, 6 or 7 years. The more history you have the easier you can identify past trends with the company and long-term success. There are still many opportunities to buy companies that have a long track record and even if you experience a backward slide, can still be a good investment in the end. You should also analyze the business both on a best case and worse case scenario and be sure you are confident you can survive even if revenues take a dive going forward. Does the breakeven analysis make sense based on what you are paying and based on the history of the company?
Lastly, sellers are still requiring more than they should be, and many are not adjusting to the realties or changes in their financial statements or changes in market conditions. You might need to walk away from deals when sellers are not being realistic to those changes. They are likely to find future buyers willing to pay less if you walk away, but that is how it works. You can also do more creative financing by offering seller notes with forgivable features if revenues or EBITDA drops off in the future to provide protection, or if not using SBA financing building earn-outs into your transaction. That way you still give the seller the upside if the company performs, but you protect yourself on the downside.
If you ever want to talk through a specific situation, we are happy to help you analyze it from a financing perspective and work through it with you. You can reach me here or directly at redacted Good luck!