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Private Company Valuations and the Economy: 5 Things to Know

02/15/2023 Bryan Setz
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It should be of no surprise that a shifting economic environment has an impact on company valuations. While the media provides a thorough analysis of the impacts on public markets, it is harder to identify the effects on privately held companies. In this article, we explore five points regarding economic events and private company valuations.

1. The economy ranks at the top of concerns for small business owners.

Maybe this is an obvious first point, but external macroeconomic forces such as shifts in the labor market, demographics, and inflation are concerning for small business owners. In a recent survey of more than 1,500 business owners by Biz-Equity, the top concerns for small businesses are as shown in the following graph. As depicted, 73% of respondents listed their top concern as economy related factors.

2. Not all industries are created equally.

Valuations should factor the industry’s sensitivity to the economy (commonly known as industry beta or industry risk premium) into the expected rate of return an investor should receive.  It should be no surprise that company values can be unevenly impacted by changes in economic conditions that directly reflect the industry rather than the company specifically.

For example, while inflation has been a top concern for business owners, it is important to note that the impact of inflation was not even across all industries. According to the Bureau of Labor Statistics, the following industries have been most affected by inflation:

  Industries One-year change in Price One-month change in prices Two-year change in prices
1. Oil and gas extraction 64.80% -10.40% 233.30%
2. Petroleum and coal products manufacturing 58.10% 15.80% 135.40%
3. Primary metal manufacturing 35.50% -1.70% 69.00%
4. Gasoline stations 33.50% 15.90% 22.50%
5. Furniture and home furnishings stores 25.80% 2.10% 41.70%
6. Motor vehicle and arts dealers 25.60% 0.60% 36.60%
7. Truck transportation 24.80% 6.70% 34.80%
8. Wood product manufacturing 24.70% 3.40% 66.00%
9. Air transportation 23.00% 9.20% 10.50%
10. Building material and garden equipment and supply dealers 22.00% 3.10% 55.40%

Conversely, other industries saw very little impact.

  Industries One-year change in prices One-month change in prices Two-year change in prices
1. Insurance 1.2% 0.00% 1.10%
2. Telecommunications 1.50% 0.10% 1.30%
3. Broadcasting -1.40% -0.80% 1.60%
4. Electronics and Appliance Stores -7.90% 2.10% 2.20%
5. Publishing 1.80% 1.70% 2.90%
6. Apparel Manufacturing 3.70% 0.10% 3.60%
7. Health and Personal Care Stores 5.10% -0.80% 1.90%
8. Computer & Electronic Product Manufacturing 5.40% 0.40% 4.90%
9. Hospitals 2.20% 0.10% 6.80%

3. Valuation peaks and valleys are smaller in private companies.

In recent years, it is easy to look at volatility in the public markets and think a private company’s value is also fluctuating at a similar rate. However, this is not necessarily the case. Private company deals take longer to close and change hands after months of negotiations and due diligence. Having a smaller ownership pool, they are vetted differently and tend to react more patiently to short-term economic changes. Consequently, the valuation multiples seen in financial news fluctuate more than those in private company deals. Historical changes in economic conditions have shown us that private companies never sell at the highest highs and never dip to the lowest lows reported in public markets. They are more stable and slower to fluctuate.

4. Local matters more.

Private companies are typically more sensitive to local and regional economic conditions than large publicly traded companies. While a global economic downturn may be of great cause for concern to a Fortune 500 company, a regional privately held company may experience little impact. Alternatively, shifting demographics or economic conditions in a given area may have a drastic impact on a company. For example, when Intel announced a $20 billion investment in a chip manufacturing plant near Columbus, Ohio, the economics of a local labor market will certainly have a greater impact on tech-related businesses in the region. Similarly, with the newly approved $1.635 billion grant to construct a new bridge connecting southwestern Ohio to Northern Kentucky, businesses in the area can expect to experience varying affects depending on their proximity to construction and altered traffic patterns. When valuing a privately owned company, an expert should consider these localized economic forces and how they compare to the macroeconomic landscape.

5. Rising interest rates reduce valuations.

The rising cost to borrow money has a direct impact on valuations. Rising interest rates on credit lines cause companies to operate with leaner inventory levels and delay capital improvements. Higher rates on senior debt make expansions and acquisitions more challenging, ultimately resulting in more due diligence before buying or selling a company. Additionally, increased debt service costs reduce cash flow. Good companies will still sell, but the multiples may be lower. Less solvent, more financially distressed companies will have a more difficult time executing a transaction. Finally, investment in new products or business lines may be postponed, resulting in a longer or delayed return period from the investment. All these elements create downward pressure on a company’s valuation.

In summary, the economy is of great concern to privately held businesses. A slowing economy and rising costs may reduce the current price at which a company can sell, but the fluctuations are not as severe as what is seen in the news. Business owners need to remain steadfast in their diligence when exploring new ventures-especially in a slowing economy.

For any questions related to this article, contact Bryan Setz, Director of Business Valuation Services, at bsetz@vlcpa.com or 800.887.0437.

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