Recession - Fall 2019

August 28, 2019

by a searcher from Dartmouth College in Allentown, PA, USA

Is buying a small business at this moment in time a bad idea? A recession appears to be right around the corner.

Is the smart move to hold water for 6-to-12 months, let the recession hit and then seek to buy a company once prices come down? I'm also concerned about putting 90% debt on a deal via a SBA loan and then having a recession hit... feels like servicing the debt could become a challenge.

Any thoughts?

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Reply by a searcher
from Harvard University in Washington, DC, USA

A great question, and obviously no way to know for sure - I wonder too... so hard to find a reasonably-priced company right now for sure. But if there is a recession, it won't be easy, then, either, to get something done that's a successful investment... so in my view, no point in waiting, and if you are trying for crystal-ball perfect timing, it's more likely to be in###-###-#### months not 6. I don't give a significant % chance to the scenario where in 6-12 months it will be so much better to buy a company than today - where the finance availability, valuation dynamics, deal competition, and seller expectations are so much better that a short pause of no work will put search funds (or independent sponsors) in a better position than working at trying to get something done now. I'm assuming recessions take longer (36+ months) to work themselves through. Two scenarios I have top of mind: Scenario 1 is a slight economic slowing, muddle through, global uncertainty, stagnation instead of recession, with asset prices remaining high, interest rates low, plenty of buyers, a mild pull back in bank credit, pressure on average investor returns in new deals (but huge wins from harvesting old investments), and low earnings growth. In that scenario, no point in waiting to buy a company, provided it is a reasonable deal with ok leverage and risk. With the Fed being pro-active that’s my base case for the next few years. Scenario 2 is a more classic recession (nothing like the 2008 melt-down) led by certain sectors (eg, capital spending, export industries, etc.), banks tightening, and customers trimming. In that scenario, it will be tough to do deals in the first 24 months – banks will be skeptical, companies will have declining fundamentals, PE buyers and strategics will still have >$trillion of dry powder and mandates flowing down to the lower-mid market, sellers will still have high expectations, comps, and valuation anchors, and many equity co-investors will be spooked by evidence of weakness and their own declining stock portfolios. If you're buying a "recession-proof" business the buyer competition will be intense. One will have to make a bet with lots of equity (and convince investors) re: the depth and significance of the recession and how that plays out for your target which in the first 2 years will be unknown, or go for distressed investing in deeply discounted cyclical in trouble... So if you believe that a classic recession is right around the corner, as described above, and are looking for nice cash-flow based businesses, it would be more likely one would have to wait 36+ months until optimal buying conditions appear...where performance is improving, you can see the light at the end of the tunnel, credit and equity is flowing, and buyer expectations are reasonable. I think this is a reasonable chance scenario – but the implications are waiting 3 years or re-orienting to distressed investing around the ~18 month mark. If one is not up for waiting 3 years, but is worried about scenario 2, then obviously considering the sector, recession risks and specific impacts on the company’s ability to pay its debt obligation is important. That’s my strawman POV – very open to feedback / debate.

Reply by an investor
from Western Washington University in Key West, FL 33040, USA

1) I've been calling for a recession since###-###-#### and so have a lot of other smart people!). Good thing I didn't hold my breath! The real answer is that no one knows when there will be a recession. If you spend your time worrying about all the what-ifs and when the next recession will happen, you'll never get anything done and you'll miss a lot of good opportunities in the meantime.

2) The goal should be to buy a high-quality business at a fair price that will allow you to thrive and survive any scenario that plays. If you pay a fair price, you should be able to build a significant margin of safety into your deal structure as well. You don't want to push your leverage to the point where you won't be able to service your debt if there is an unexpected decline in revenue (whether from a recession, loss of a big customer, etc.). If you have a good business and a stable capital structure, you will actually be in a much better place to take advantage of any opportunities that may come about as a result of a recession. Who do you think is going to be able to better capitalize on opportunities in a recession - an established industry player or a relatively inexperienced recent MBA grad with no capital of their own?

3) Even if the scenario you're worried about/hoping for actually does play out, who's to say the debt and equity capital that is currently available will still be available then? Or that sellers will be willing and able to sell at a depressed multiple on depressed earnings? Capital and willingness to sell tend to dry up in a recession...

Frankly, you sound like EVERYONE else in the world right now who is HOPING that a recession will come so that they can blindly buy assets at cheap valuations and get rich quick and easy rather than actually having to work hard to find/create new opportunities.

Ignore the noise.

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