Scylla AND Charibdis - a Perfect Economic Storm

Let's talk about a storm that's been brewing in the business world – high interest rate front colliding with one of overheated multiples. There’s a lot going on here, but we’ll break it down for you.

The Lay of the Land

Picture this: you’re out shopping for a new business. You've got your eye on a what you think is a promising one. There may be a challenge before you even get started. Demand for high-quality businesses is driving prices to multi-year highs, while at the same time interest rates are reducing the amount of debt the business’s cash flow will support (for all of you who have been in the market for a house in the last 18 months will be able to appreciate the impact that interest rates have on affordability) These two forces can conspire to force a buyer to either bring more cash to the table, find other structural adjustments to make a deal happen, or both.

High Interest Rates: The Party Poopers

High interest rates are like those party poopers who show up and make everything more expensive. When borrowing money costs more, every dollar you invest needs to work that much harder just to break even. Your friendly neighborhood bank isn’t being mean – it’s just math. Interest rates serve as gas and brake pedals on the economy, so in the present the interest rates are meant to slow down the inflation we’ve all been experiencing. While that would be great and I’m sure we’d all enjoy easing prices at the store, it’s less than convenient if you’re looking at a large purchase. Higher rates mean higher loan payments, which will squeeze your cash flow like nothing else.

Overheated Valuations: The Seller's Market (kind of)

Now, toss in overheated valuations. Imagine everyone wanted to buy the same trending item – say an insulated beverage mug, popular high-tops, or famous handbag for instance. ?Popularity and demand drive prices, and suddenly, everyone wants it and we even begin to see some FOMO (Fear of Missing Out). That’s what’s happening with businesses right now. Everyone’s excited, bidding wars break out, and prices shoot up. But here’s the kicker – sometimes, these businesses aren’t worth what people are paying. They’re just caught up in the hype. By and large, though; the ones that ARE commanding the higher prices and getting across the finish line enjoy the attributes mentioned below:

Quality of Earnings: The Real Deal

In these times, it's crucial to focus on the quality of earnings. What does that mean? Simply put, it's all about looking at how sustainable and reliable a business's profits are. High-quality earnings come from solid, recurring revenue streams, not one-off sales. You want to make sure the business you’re eyeing isn’t just a flash in the pan but has steady income you can count on.

Operational Systems: The Backbone

Next up, let’s talk about the strength of operational systems. A business with robust, efficient systems in place runs like a well-oiled machine. It means fewer hiccups and more consistent performance. When interest rates are high, and valuations are through the roof, investing in a business with strong operations can be your saving grace. It’s like buying a car that doesn’t break down every other week – worth every penny.

Healthy Margins: The Comfort Cushion

Healthy margins are another key piece of the puzzle. They provide that nice, comfy cushion when times get tough. Businesses with fat margins can better absorb the impact of high interest rates. They have the wiggle room to handle extra costs without breaking a sweat. So, when you’re assessing a business, look for those juicy margins – they could save your bacon.

Seller Financing: a Strategic Solution

Here’s a silver lining – seller financing. Some sellers might be willing to finance a portion of the purchase price. It’s like getting a little help from the previous owner. This can ease the burden of high interest rates and make the deal more palatable. Plus, it shows the seller’s confidence in the business’s future; making a lending institution more confident as well.

Navigating the Storm

So, what’s an entrepreneur to do? First, keep your head cool. Do your homework. Look beyond the excitement of a frenzied market and your own desire to take a chance on yourself. Assess the real worth of a business – its quality of earnings, operational strength, and margins. You’ll also want to assess whether there are any external factors that could affect the business in the future (ie – how does that particular type of business perform in a recession, or are there any pending regulatory changes that could affect its industry?) And, be mindful of those interest rates. If borrowing costs are high, you might want to reconsider or look for better financing options, including seller financing for some or all of the transaction.

Remember, in the world of business, slow and steady often wins the race. Don’t let the hype lead you into a sticky economic trap. In fact, investing in the services of qualified professionals to begin with will pay dividends as an ounce of prevention.

Stay savvy out there!