Your business does not operate in a bubble. It operates in a complex and dynamic marketplace. Let’s look at some important valuation variables that are outside of your control as a business owner. It can be useful to understand these variables and the impact they can have on your business valuation so that you can capitalize on favorable conditions and also mitigate potential downside risks. By comprehending these dynamics, you can align your growth strategies, operational decisions, and financial planning with the expectations and demands of the external marketplace, enhancing your business's attractiveness and value. Being thoughtful about how you approach the marketplace – and where you fit in – will help you build a resilient company that can adapt to external forces and be set up for long term success. It’s also important to note that you must take active steps to avoid the biggest risk to your valuation: going out of business or seeing a significant decline in business.
The valuations of all businesses are impacted by macro-economic conditions and many times local economic conditions as well – for better or for worse. And it’s not just market conditions you need to think about – it’s also perceptions of market conditions, which may be entirely different. You don’t need to have a crystal ball – which is impossible – but you should keep an eye on which direction the economic winds are blowing. All business owners should take the time to think strategically about the economy and how it impacts their business. To protect your valuation, you can’t afford to be blindsided by economic events.
Let’s go over some basics. If the stock market is booming, consumer confidence is high, interest rates are low, and the economy seems sure-footed, private company valuations will generally be higher. If there’s an economic recession, interest rates are higher, and there is fear in the marketplace, private company valuations will generally be lower. This is oftentimes regardless of the performance of your actual business. It’s a way of pricing in both perceived business risk and the cost of borrowing money. The higher the perceived risk, the lower the valuation. The higher the interest rates, the higher the cost of borrowing money, and the lower the valuation – especially for businesses that are capital intensive or more dependent on debt markets. This may seem obvious, but many business owners don’t pay attention to this when thinking about the value of their business and timing the sale of their business.
Perception is also reality. People’s subjective opinion of the direction of the economy also matters – even if it’s at odds with actual conditions. This is one of the reasons why valuations are highly subjective and change constantly. It’s also important to note that there are some counter-cycle exceptions. Some businesses tend to be stable or even thrive in economic downturns – and could even see a higher valuation during recessions because there is demand for investment in “safe harbor” or “recession resistant” businesses.
Similarly, local economic conditions can also impact business valuations, especially for certain types of businesses that depend on a local customer base. For example, if your business is based in a location with a fast-growing population and high levels of new investment, your business will likely be worth more than if you’re located in a location that is declining in population, losing jobs, or otherwise economically depressed. Local taxes and regulations can also be a factor with many business buyers preferring operations in lower-tax, lower regulation states.
What matters most is understanding that your business does not operate in a vacuum, and you need to be sensitive to economic conditions or trends when you’re thinking about your timeline and plan for selling. If you have a specific timeline in mind for retirement, for example, you need to keep an eye on economic conditions to determine whether you should move your timeline up or back – and have a plan in place for both scenarios, similarly to how you may think about the funds in your 401K or retirement account.
As a business owner, it’s important to have contingency plans in place for economic downturns or changes in the debt markets so that you’re not blindsided and forced to sell at a disadvantageous point in time. You need to have enough funding in place and be in a strong enough position to be able to react to changing conditions quickly. You destroy business value if your business becomes distressed or if you’re pressured into a sale due to economic conditions you weren’t prepared for. Give your business the ability to survive through downturns and live to fight another day. In some cases, if you put yourself in a strong position, you may even be able to take advantage of downturns buy buying competitors who weren’t as prepared. Or you might be able to make strategic investments when costs from suppliers or vendors are lower. The goal is to see around the corner (a little bit) and have a plan that keeps your business stable in good times and bad – taking advantage of tailwinds when you can and minimizing the impact of headwinds when you must.
