At the current time business brokers have reported a flood of purchasers pulling out of sale contracts prior to settlement. New purchaser enquiry has also slowed dramatically. The reflex reaction to the coronavirus situation, is that many small businesses such as restaurants or retail shops selling discretionary items, would attract far lower prices. But this sentiment is not representative of market value, but rather the short-term forced sale value, where a vendor has to sell quickly. It is interesting to note, that some segments of the market, where there is inelastic demand for products and services, are still attracting reasonable purchaser demand.
Even before the Coronavirus Pandemic, the lead up in 2019 was a year of economic and business uncertainty. Brexit, USA and China trade war, Hong Kong riots, negative interest rates/inverted yield curves have all played a part in restraining global business and consumer confidence. Locally, it was a year of natural disasters with drought, storms/floods and bushfires. The result of all of this, was Australia’s GDP growing at only 1.7% in the 12 months to December 2019. This is far lower than the RBA growth outlook of 3% for the year, that was made in early 2019. When the 2019 GDP is analysed on a per capita basis it actually fell by around 4% between June 2018 and June 2019.
Towards the end of 2019 and in the first two months of 2020, there was a feeling that to an extent, Australia had weathered many of the above factors. Housing prices across the nation were on the increase and consumer confidence likely to follow this. Then came the Coronavirus to stall both the Australian and global economies.
The starting point for the Australian economy in 2019/20 was the effect of the aforementioned natural disasters. As bad as these were, it is estimated that they would only account for a 0.3% fall in GDP growth over the next two quarters. This is significant in the short term but will be overcome in the medium term. The unemployment caused in these areas was to be somewhat offset by the rebuild after bushfires in the medium term. Some sectors such as tourism and retail would however have medium term job losses.
Modelling carried out by former RBA Board member Dr Warwick McKibbin provided a range of six main scenarios as to the effect of Coronavirus on Australia’s GDP. The scenarios that include global spread of the virus (as has become the case), estimate a range of negative 2.1% to negative 7.9% to Australia’s GDP.
Given that Australia’s GDP grew only 1.7% in the 12 months to December 2019, this means that there is a likelihood Australia would slide into recession, without significant fiscal and health policy responses. As can already be seen the Australian government and Reserve Bank have quickly reacted with the following:
- RBS monetary policy with interest rates lowered – this has not only reduced the cost of borrowing but also lowered the value of the Australian dollar to act as a buffer for the economy.
- The Reserve Bank provision of $90 billion of funding in a facility to help banks lend to business.
- Australian government’s $66 billion supplements to unemployed and welfare recipients.
- Australian government $130 billion stimulus of $1,500 per fortnight “JobKeeper” payments.
- State government measures reducing fees and charges.
All of these measures are aimed at offsetting the potential GDP losses such as those estimated by Dr McKibbin. Economic commentators have broadly agreed that the stimulus measures should have a positive effect. It must however be noted that global imports from China were around 4% lower in January/February 2020 and its exports plummeted by over 17% over the same period. Similar decreases in trading with Australia’s other main trading partners are likely given the following main reasons:
- Port closures/quarantine/supply chain disruption.
- Decline in global consumer confidence and demand.
- Both of the above led to declines in manufacturing activity in countries such as China and South Korea.
In the end, the full effect of the Coronavirus, will be highly dependent on its spread and length of time that it impacts. As such, the disruption in an economic sense, will depend on the success of various country’s lock down measures, economic stimulus policies, and timeframe in finding a vaccine or cure. Best estimates for a vaccine appear to be around 18 months. It is hoped that lock down measures and economic stimulus will allow business and economic activity to pick up again well before this. In this regard there are some early signs that China is already starting to re-ramp up its manufacturing sector.
CORONA VIRUS EFFECT ON SMALL BUSINESS VALUES
Given the uncertainty created by the Coronavirus situation and other Australian global economic events, firm forecasts for business values over the next 12 months are not possible. History does however provide indication as to likely impact caused by the recession predicted to follow.
There is no doubt as to the immediate and significant impact of the Coronavirus on the small business market. This author has personally fielded calls from business brokers around the country, reporting that most of the business sales transactions that they have been working on in recent months, have fallen over or been delayed prior to settlement.
The reactionary stance fuelled by social media, fear etc would lead to a belief that businesses like restaurants, hairdressers, beauticians, and tourism businesses are now worth very little. Conversely that supermarkets, medical practices, toilet paper and cleaning product manufacturers/suppliers are worth a lot more. This perception is wrong for two main reasons:
- Concept of future maintainable earnings: Well informed business purchasers make decisions based on future maintainable earnings – not the profits or losses caused by short term events. They will be looking at what the trading looks like when the Coronavirus situation is resolved.
- Definition of market value: This includes the premise of a willing seller acting without compulsion. i.e. the owner of a restaurant forced to sell their business right now may only achieve the forced sale value, rather than market value.
These fundamentals, together with the natural forces of supply and demand, are what the market will return to, once the panic sentiment in the community dissipates.
So, we are better to contemplate the impact on small business values in the medium term. This will take account of not only the Coronavirus, but the previously mentioned factors of uncertainty in the economy. In summary, the main medium-term economic factors include the following:
- Initial period of government stimulus will have to be tightened eventually to a position of once again paying off debt.
- Low interest rates – look likely to remain for an even longer term now. This will aid government in the paying debt. It will also aid businesses and consumers paying off debt as well as encouraging investment. The likely long-term scenario of low interest rates will give confidence to small businesses.
- Low Australian dollar. The lower Australian dollar provides a direct benefit to export businesses.
- Likelihood of a recession/ higher unemployment, resulting in loss of consumer confidence and demand
So, we have an environment of government stimulus and low interest rates trying to stimulate demand. This is set against uncertainty and a probable increase in unemployment that may lead to global recession. In this uncertain market there will be an even stronger propensity to purchase small businesses with lower risk – businesses having characteristics including the following:
- Products or services for which there is an inelastic demand curve.
- Recurring customer base.
- Consistent recurring revenue.
- Positioned in a growth industry
- Businesses types for which there is strong demand and a limited number of listings (tend to be business types with the above characteristics).
BUSINESS TYPES LIKELY TO OUTPERFORM
In a general sense, it is predicted that if unemployment were to rise substantially, that this will increase demand for smaller “buy a job” businesses of various types. Beyond this part of the market, examples of businesses that will be likely to sell well in the marketplace include:
- Financial services (e.g. accounting, insurance and financial planning).
- Non-discretionary retail (e.g. supermarkets, liquor store).
- Non-discretionary manufacturing/wholesale (e.g. essential foods, cleaning products).
- Essential services (e.g. medical, aged care, education, security, energy/ power generation).
- Maintenance businesses – as consumers/ businesses look to repair cars, plant and equipment etc rather than make large new capital purchases.
- Growing industries (e.g. online retail/wholesale, technology businesses, mining services, environmental/solar businesses).
BUSINESS TYPES LIKELY TO HOLD STEADY OR HAVE ONLY MODERATE DOWNSIDE
- Domestic accommodation/ tourist businesses – given that Australia in recent years has had more outbound tourists than inbound, if more Australians decide to holiday locally this sector will likely benefit. This is due to potential fear of overseas travel and also the lower Australian dollar making it more expensive to travel overseas.
- Lower priced restaurants/takeaway foods as they are not high discretionary spend items.
- 3rd party logistics and outsourcing businesses – as businesses look to gain efficiencies/ offset the risk of having internal staff and investing capital.
- Selected construction businesses in infrastructure, road, rail etc.
- Some businesses that have demonstrated reasonable trading during the Coronavirus lockdown, will get an extra tick given this sign of resilience.
BUSINESS TYPES LIKELY TO UNDERPERFORM/FALL IN PRICE
- Higher priced discretionary retail businesses (e.g. new car and boat sales yards, travel agencies (international focussed), high end jewellery and clothing shops).
- Upmarket restaurants/eating houses.
- Discretionary service businesses (e.g. limousines, high end beauty).
- Wholesalers/manufacturers of discretionary goods (e.g. upmarket furniture, art).
- Non- Essential Consultants – government and private businesses tend to minimise use of external consultants during recessions.
IMMEDIATE ADJUSTMENT TO SOME BUSINESS VALUES
Vendors, business brokers and valuers cannot ignore some already tangible impacts of the Corona Virus in the current marketplace. If purchasers are willing to transact at the current time, allowances would have to be made in situations such as the following:
- For businesses that are in a forced closure situation due to government restrictions – allowance needs to be made for the holding costs associated until re-opening. There may also be costs associated with a marketing initiative to get customers back, once allowed to resume trading.
- For project work businesses – if the forward book of contracted book of work to do has diminished (contracts cancelled) then the revenue, profit outlook and value for these businesses must be adjusted accordingly.
- With most economic forecasters predicting a recession – those business types that are seen as having downside risk are likely to attract lower multiples against profit. The resulting potential discount to business values is not yet able to be measured – we will need market evidence going forward to make adjustments – but in the meantime a conservative view for these business types may have to be taken for vendors/ brokers listing prices.
ADVICE TO BUSINESS OWNERS
When the initial panic caused by the Corona Virus is over, business purchasers will return to the market. This may even be in the short term, as the recently unemployed look to enter the market. Purchasers will once again start to base decisions on the longer- term fundamentals of:
- Future Maintainable earnings
- Individual business risk profile
With this in mind, it is important that owners looking to sell are active in preparing their businesses for sale to ensure that they achieve the full market value rather than a “forced sale value”. Measures that can be taken include the following:
- It is recommended that a diary be kept of the effect of the corona virus – e.g. period of shut down, period of staff working less hours/ working from home etc
- Keep very detailed financial records of effects of the corona virus period on revenue, additional expenses etc – the idea behind this is so that this period of unusual trading can be effectively excised from the business and “normal trading” be identified. Good, up to date accounts will be even more important going forward.
- Consider engaging the services of a business improvement consultant to prepare your business for sale – this may be particularly relevant if your business type is one that may be in the “underperform” category as detailed above – are there measures that can be taken to make changes to your business model and reposition it in the marketplace?
- Engage with a business broker well before putting the business on the market – a good broker will also work with the client to prepare the business so that it is ready to sell.
- Consider options of providing vendor terms to purchasers where appropriate. This can be in the form of retentions, earn-out rights etc. Provision of vendor terms may aid in achieving a significantly higher price in the current market, where access to finance is more difficult – it is however recommended that you get expert advice in structuring/ contracting this correctly.
The full effect on the market values of various business types, caused by the Coronavirus, is not able to be confidently predicted at the current time. This will only be able to be determined by market evidence over the next 12 months. Even with this evidence, care will need to be taken to differentiate between forced sales and more orderly market transactions.
At this time, the Business Values Newsletter price list relies on market information sourced up until the start of March, being before the effect of Coronavirus. Whilst the author does expect some changes to prices as we likely move into a weaker economy, it is not envisaged to be as dramatic as it feels right now.
That said, businesses that were already struggling prior to Coronavirus and do not have the financial capacity to cope with the period of lockdown/low activity, are likely to be pushed into a forced sale position or even closure. This is where opportunistic “value buyers” may come into the market. There will also likely be an increase in merger and acquisition activity, as stronger players in marketplace, see the opportunity to buy other business’, assets at lower prices in their weakened state.
The medium-term effect of Corona Virus is likely to be a global recession. With this in mind, the types of businesses that are likely to outperform are those with lower risk profiles (less reliant on high value discretionary spending) or those with exposure to growing industries.
NUMBER OF BUSINESSES LISTED FOR SALE
|Mar 19||Dec 19||Mar 20||Dec 19 to Mar 20 |
| Mar 19 to Mar 20 |
This table reports the number of businesses listed for sale on the Seek Commercial website with listing prices of $50,000 or greater (excluding new franchises/licences)
PRICES OF LARGER BUSINESSES
Every April issue of the Business Values Newsletter includes a table showing the appropriate ROI percentage for a range of larger businesses. Subscribers can calculate a ballpark estimate of a business’s value using the below ROI table. Please refer to the “How to calculate an estimate of business value using BVN price list document” in the Jarot Business Valuations online members library. BVN subscribers can also refer to the Index Sheet to find the latest article about a particular business type.
For businesses with higher profits, these can either be valued on the basis of the profit being calculated, as being run by an owner operator, or under management. For smaller businesses the owner operator (i.e. no salary for one owner in the expenses) approach is the most appropriate. However, when profits exceed around $800,000, the preferred approach is under management (i.e. include an appropriate wage for the owner).
Whichever method for calculating the profit is used, it does not affect the price of the business. What occurs is the ROI percentage changes accordingly, so that the price is the same.
The table below includes both approaches so subscribers can use whichever method they consider appropriate to best reflect the specific business type/ marketplace. For this exercise, it has been assumed that a fair salary for the owner is $150,000. Obviously, this salary should be looked at in relation to the size of the business and other relevant salaries in the industry in which the business operates. In some cases, a lower salary down to $100,000 may be appropriate and it could go up to $250,000 or more for larger businesses. It should be noted that the profits used in the table are based on having all interest and depreciation expenses added back. The only exception is depreciation in hire businesses which is not added back.
Please be AWARE these figures are only a guideline and are based mainly on sales in the Perth market. Other state and country business prices are generally within + or – 10%. However, it should be noted that due to the small number of these businesses being sold each year, there are greater fluctuations in actual sale prices occur. This especially applies to exceptional businesses which often attract a premium above market rates. Professional advice should always be sought before putting a price on a particular business.
BUSINESS PRICE UPDATE AS AT MARCH 2020
It should be noted that the below table of prices is based on market information before the Corona Virus impacted the Australian economy – in relation to this see comments in the market update section of this newsletter
Businesses in demand
The following business types are currently in demand or proving difficult to sell – this does not take into account the short-term impact of the Corona Virus.
- Accountancy Practices
- Veterinary Practices
- Health and Medical – selected sectors
- Service – Selected repeat client sectors
- Online businesses
- Work from home businesses
- Technology Businesses – subscription revenue model preferred
- Wholesale – Non-Discretionary Products
- Manufacturing – selected repeat client sectors.
DIFFICULT TO SELL
- General Retail
– Discretionary Spend
- Clothing Boutiques
- Lotto Kiosks
- Travel Agencies
- Restaurant/ Café
- Profits less than $100,000
The following borrowing rates, as at 15 April 2020 were provided by Hadmor Pty Ltd t/as Southshore Finance ACL 393334 (Phone 08 9474 1999).
Interest rates are indicative at the above date and subject to a formal application meeting the lenders criteria. The actual rate will vary depending on market conditions and aspects of the finance application including credit worthiness, capacity to service and security offered.
Business Loan – Secured
Fixed 2 Years
Chattel Mortgage Equipment
Fixed 1 Year
Fixed 3 Years
15 April 2020
Owner Occupier – Principal & Interest Variable
Fixed 1 Year
Fixed 3 Years
Residential Investor – Principal and Interest
Fixed 1 Year
Fixed 3 Years
15 April 2020
Finance Market Comments By Southshore Finance
What an interesting world that we live in! Just as the WA economy was showing signs of sustained growth, along comes Covid 19.
There has been a significant impact on the finance community with the major lenders all participating in a program of repayment deferrals, loan restructuring and special Covid 19 working capital loans. These are unprecedented times and the lenders have committed huge human and financial resources into trying to assist borrowers through this period and should be commended for doing so.
Funding for new business acquisitions/expansion is restricted due to current market conditions. New funding requests are subject to intensive scrutiny, with a particular focus on the ability of the business to cope with the fallout of Covid 19. However, there are businesses performing well in the current market and lenders remain keen to assist well managed and robust businesses.
There will, no doubt, be opportunities arise as the Covid 19 issue subsides. Good business operators will use the current situation as an opportunity to “reinvent” their business, restructure and recapitalize and be prepared to act when those opportunities present themselves.