Small business valuations relative to economic cycle

January 28, 2020

by a searcher from Harvard University - Harvard Business School in Jersey City, NJ, USA

Hi all, if the goal of a search is to buy and run a small business for an extended period, e.g. 10+ years, it seems like it would be better to search in a downturn/recession vs. when valuations are generally high. Given the general consensus that the US is late in its current cycle, it could mean more opportunities will arise once the next recession/downturn begins. Curious if others agree as well as any research/analysis on the relative exposure of small business valuations to economic cycle and broader stock market valuations (vs. how uncorrelated or insulated they might be). Thanks in advance for any related thoughts, alternative viewpoints, or other considerations.

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Reply by a searcher
from Carnegie Mellon University in Boston, MA, USA

Speaking with inexperience here, but my expectation is that the vast majority of businesses ARE correlated with the broader market of course. So many businesses out there are largely exposed to discretionary spend, the capital cycle, new construction, and you should fully expect their revenues and profits to dip accordingly. Many of us are looking for businesses that are insulated from that cyclical stuff of course, but they're harder to find.

I've had the same thought in the past that I would want to launch out on this AFTER the next downturn, but my understanding is that business owners are savvy enough to know when their values are depressed, and unless they're in dire straights with health or otherwise, a lot of owners will hold off on selling until they get the business back to a reasonable level.

I know in the last cycle, debt was virtually non-existent for a time as well and so you just saw far less on both sides of the supply/demand side of the deal environment from ~###-###-#### at least. Curious to hear from people who have lived it of course though!

Reply by a searcher
from Brigham Young University in Kaysville, UT 84037, USA

I face similar concerns and thoughts.. especially given my industry experience is in real estate which is obviously very cyclical. One thought I've had is to target an opportunity that is counter cyclical to real estate/construction. So for example a company that preserves/maintains properties for foreclosed properties by banks. They wouldn't have a lot of business right now but in the down cycle should have significant growth. My nature is to want to time the market with strategies like this. I should probably be more focused on a boring company that is steady through all cycles.

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