A total of 2,454 small businesses were reported sold in the third quarter of 2019, an 8.6% decline compared to the same period last year according to the BizBuySell Insight Report, a nationally recognized economic indicator that aggregates statistics from business-for-sale transactions reported by participating business brokers nationwide. This continues the trend of reduced transactions seen throughout 2019.
While it’s important to note that transactions remain high historically, uncertainty about international tariffs is creating a challenging environment for some deals. More specifically, business valuation becomes increasingly difficult when having to consider increased costs due to tariffs with an unknown duration. According to a BizBuySell survey of business brokers, this has become a real issue for sectors reliant on international partners such as China. Perhaps the most effected being those in the manufacturing sector.
“Manufacturing businesses are commonly being hurt by tariffs on Chinese bought parts. This depresses margins and profits which in turn drives down the valuation,” said one business broker. “I have five manufacturing companies for sale. Each is worried about tariffs,” added another.
However, it’s not just costs that are being impacted. Tariffs are also having an indirect impact at the register. As reported in BizBuySell’s 2019 Buyer-Seller Confidence study, at least 1 in 3 business owners (37%) has experienced tariff-based cost increases, with half of them raising prices to offset the higher costs. Forty-six percent of those owners saw sales decline as a result.
According to Scott Bushkie, managing partner of Cornerstone Business Services, the ability to successfully pass along increased costs lies in the uniqueness of the products and services.
“The more niche or proprietary the company, the more successful they are at passing on tariff costs to clients,” Bushkie said. “It’s the commodity type businesses that are hesitant to pass on costs out of concern of losing business. As a whole, tariffs have been one of the stronger headwinds for lower middle market deals in 2019.”
For business owners, tariffs have understandably caused concern, as illustrated by the 2019 Seller Confidence Index which declined to 52 from 58 a year ago. Conversely, the Buyer Confidence Index rose from 47 to 53 over the same period, perhaps indicating a sense of opportunity to leverage increasing economic uncertainty as a means to negotiate better terms.
Given that an Index of 50 represents neutral confidence on a 0 – 100 scale, the two positive scores indicate both parties are unlikely to quickly concede during negotiations. The resulting stalemate is a likely contributor to slowing transactions. “Tariffs have been a very minimal issue. They’re just causing a bit of hesitation, but are also something to press in seller concessions during negotiation,” said one broker.
According to brokers, the onus may lie with the seller to adjust their price in today’s market. More than half of brokers describe 2019 as a buyer’s market versus just 27% who believe it favors sellers and 21% who see a balanced market.
One broker offered a solution that may satisfy both parties in the midst of valuation uncertainty, explaining, “Partial earn-out clauses will mitigate and be put in deals to increase/decrease total price over/under historical norms.” These agreements can protect buyers from known risks that may reduce profits following a purchase.
For the moment, however, it appears the market is being influenced more by sentiment than reality. The majority (59%) of brokers have yet to see a material impact to business values based on tariffs. That could change if trade policies drag into the new year.
“I expect we’ll see more impact on business values in 2020 with tariff-related increases in cost of goods and other expenses,” said a business broker. “Effects yet to come. Too early in the game,” another added. For those buyers ready to act, there remains a healthy supply of businesses for sale. In fact, the total number of businesses listed for sale crept up 1.7% in Q3 2019 as compared to the same time last year, which allows buyers to be more selective in their search. The top supply driver continues to be retirement-seeking Baby Boomers, who have accounted for at least 60% of 2019 sales according to the majority of business brokers.
Meanwhile, 11% of brokers have encountered an owner looking to sell due to tariffs. For some older or burnt out owners, tariffs are just the final encouragement to bow out. “The International tariff policy is causing older owners of manufacturing companies in the $5 – $15 million range to think about throwing in the towel,” said one broker. Another added, “Margins are less and owners are tired and don’t want to go through another protracted period like the recession.”
In comparison to owners, 18% of brokers have experienced buyer hesitation, which might be the more important of the two groups to monitor. Surveyed brokers say a reversal in course from today’s positive buyer confidence levels is the top threat facing the business-for-sale market, slightly higher than uncertainty around the 2020 election. “If buyers think this is the wrong time to buy, it will be a bigger threat than any other single factor,” said one broker. “But, if buyers want to buy, there will be plenty of sellers who will be willing to sell.” Over the past two years, the majority of surveyed business brokers sold at least 50% of their listings. By the numbers, there is little evidence that sale ratio will change. Buyer confidence grew over the past year, and despite a seller confidence dip, owners still remain positive. Furthermore, inventory remains strong. And most importantly, revenues and profits, the best indicators, are at all-time highs meaning businesses are either adapting to economic changes, or the effects are yet to be felt.