How Inflation Affects The Sale Of Your Business
We have recently entered a period of high inflation. Since 1970, the rate of inflation on average sat at around 3 to 3.5%. Since 2020 and the covid pandemic, the inflation rate has doubled and now sits at 7.2%. This is happening for various reasons such as a combination of supply chain disruptions, increased supply of money, and low interest rates. Inflation has numerous effects on both operating and selling small businesses. While the effects may not be immediate, high inflation is harmful to businesses over time. “Inflation hurts the purchasing power of a currency as prices of goods and services go up. Interestingly, prices go up fast during inflation but are gradual in coming back down, if ever” (Signature Analytics).
Increased cost of goods and services means that the dollar has much less buying power. This, in turn, increases the expenses associated with running a business as raw material and labor costs rise. According to business.org, Since 2020, 82% of businesses have reported having to raise their prices between 15% and 20% to counteract inflation. We have already seen price changes of multiple goods, gas has increased significantly, cups of coffee are pricier than before, and for small businesses, operating costs have skyrocketed. As business owners are forced to raise the price of services to combat this, customers are no longer able to afford the same services, potentially reducing the overall sales of these businesses. The combination of increased expenses with lower sales can be detrimental to a small business’ valuation, reducing its Seller Discretionary Earnings, and consequently the price at which it will sell for.
As such, it may be a good idea to sell now, before inflation and its effects worsen, further exacerbating these issues. The Federal Reserve set interest rates historically low to help stimulate economic growth during the COVID 19 pandemic, but plan to have several interest rate hikes in 2022 alone to help combat inflation. However, at the moment, interest rates are still low, meaning it is much easier to borrow money than usual. This means that selling a business now could be much easier and more profitable than in the future as there are more individuals with access to loans, greatly increasing the buyer pool. As interest rates rise over time to combat inflation, this will no longer be the case, making it harder to find buyers and sell your business for your desired price.
Low interest rates also act to bolster consumer spending, “When interest rates are low, consumers tend to borrow more money, and they put that money back into the economy by spending more on products and services. Lowered interest rates mean the cost of paying back a loan is less than it used to be, and then the savings people gain creates more disposable income” (Chron). Increased consumer spending coming out of the pandemic may be bolstering the sales of small businesses in the short term and may wane as rates increase to counter inflation.
According to a Fortune article by Megan Leonhardt, 45 percent of small business owners are taking out loans, and many of them are doing so just to stay in business. 63 percent have recorded having a significant increase in the cost of goods sold, and 25 percent have recorded having significant wage increases. In general, inflation is making the cost of operating extremely higher for small businesses. Increased rates also make it harder for owners themselves to borrow money to expand their business, potentially stagnating growth and hurting the value of a business, as, “higher interest rates mean it will be more difficult to take out new short-term loans to help pay for unexpected expenses or to expand your business when necessary. This can short-circuit the growth of your company for months or even years”(Chron). If costs are increasing by 40 percent, selling now is much better than holding and waiting for inflation to go down to from 7.2% to 3%. All in all, there is no better time to consider selling a strong small business than now.
If you’re considering selling now or soon, please reach out today.
Aaron Thom
President, California Business Advisors, Inc.