Economists are divided on whether Australia is headed for a recession. While the Federal Treasurer is insisting neither Treasury nor the RBA is currently forecasting a recession, several leading market analysts are assessing the chances of a recession in the next 12 months as probably 50/50.

The signals are certainly mixed.

Since May 2022, the RBA has lifted the cash rate 11 times to 4.1%. While it seems to be having the desired effect with inflation down from its peak of 7.8%, inflation remains more than double the RBA’s target. At the same time, recent employment data shows unexpected resilience in the jobs market.

Our near-neighbour, New Zealand, has not been quite as lucky. New Zealand recently entered a technical recession, but New Zealand’s central bank was more aggressive with interest rates than the RBA and New Zealand also lacks Australia’s strong population growth.

So, perhaps the 50/50 call of a recession from the likes of AMP Capital are about right. The bottom line is that we are entering a period of increased economic uncertainty. All of this raises an important question for business owners: is now a good time to consider a business exit? As you would expect, there is no single answer to that question.

Distressed sellers may have no choice

For some business owners, now is definitely the right time to sell – whether the economy is facing a downturn or not.

For example, if a business is already under financial strain – perhaps even independent of the current state of the economy – and the owner believes things are likely to only deteriorate further, selling now rather than waiting for things to be even worse in a year’s time may make sense.

Questions about a recession in such circumstances are essentially irrelevant.

Similarly, an owner’s personal financial circumstances may demand they sell their business now – irrespective of whether the economy is about to enter a recession or not. If the owner urgently needs liquid funds to meet other obligations or to sure up other interests, selling a business now may be the only sensible course of action.

But let’s put these sorts of “distressed seller” situations to one side and consider the broader question of selling a business in a downturn.

Different sectors are affected differently

An important consideration in weighing up whether to sell a business during a downturn is to recognise that even during a recession, different sectors of the economy are often affected differently. It’s common to hear fund managers referring to “defensive” stocks – companies and sectors that tend to be less vulnerable during a broader downturn.

A traditional example of a sector that fund managers tend to avoid during a downturn is consumer discretionary – businesses that sell products and services consumers see as non-essential and ones that they can go without during tougher economic times.

The upshot is that even during a recession – particularly a relatively shallow recession – some sectors may well be less affected than others. Indeed, there are likely to even be certain sectors that continue expanding during a recession because they are underpinned by economic forces beyond discretionary consumer spending.

It is, therefore, essential that a business owner in assessing the merits of an exit during a downturn, considers the specific circumstances and trajectory of their business. Drawing blanket conclusions is likely to be a mistake.

A recession may have a profoundly negative impact on the prospects of selling certain types of businesses at an attractive price. Therefore, for some businesses, it is likely to be sound advice to hold off on selling – all other things being equal. However, for many other businesses, a downturn may only have a negligible impact or even no impact at all.

For example, our firm was recently approached by the owner of a chain of fast fashion boutiques seeking our advice on a sale. Our assessment, after carefully considering and discussing the business’ specific outlook, was to delay any efforts to sell the business. The ongoing slowdown in consumer spending would likely directly work against the shareholders achieving the sorts of outcome they were seeking. That may be different in six or 12 months.

By contrast, in our recent discussions with the owners of an industrial services business, our advice was very different. Given that the business’ main clients operate in the infrastructure sector, we believed that that any economic downturn would have, at best, a marginal impact on the level of interest among potential acquirers.

To date, our discussions with possible buyers for that business have vindicated that perspective.

There are still plenty of “cashed-up” investors

It is also important to realise that deep-pocketed acquirers remain active. In the current market, it is broadly true that rising interest rates are leading consumers to reduce their spending. However, that does not necessarily mean that acquirers are automatically being forced to do the same. According to the Australian Investment Council, there is about $26b of private capital waiting to be deployed in Australia.

That is capital that these investors need to deploy. Generally, it’s a case of, “use it or lose it.”

It’s also valuable to recognise that private capital investors – such as private equity funds and family offices – tend to be longer-term investors. As a result, if a deal makes sense to them, they are less likely to be scared off by what they perceive to be short-term challenges like a spike in interest rates or a shallow recession – if one actually happens. They are looking three, five or seven years down the track to identify compelling opportunities.

Now, that’s not to say private equity-style investors simply ignore economic conditions. Rising interest rates may lead them to lower their appetite for debt, which may in turn reduce their willingness to match the sorts of multiples they might have paid in a more “frothy” market. However, it is equally a mistake to assume that there will not be “cashed-up” buyers in the market to acquire quality businesses – even in a recession. The data says otherwise.

In addition to private equity investors, public companies and multi-nationals that operate in non-discretionary sectors of the economy may also remain poised for acquisitions. Indeed, these businesses often see economic downturns as opportunities to undertake industry consolidations.

Getting the best possible sale price

For business owners that remain interested in exploring a sale during an economic slowdown, there may be ways to minimise the short-term impact of a recession on valuation. Just like sellers were concerned by the “one-off” impact of COVID on business valuations, a recession can similarly yield valuations that owners believe do not reflect the true, underlying value of their business.

At a certain point in any negotiation, the parties often reach a stalemate on forecasts and valuations. That can be a particularly acute challenge in an economic downturn when there is material uncertainty about the future performance of a given business and the economy more broadly.

One way that a seller can look to overcome that challenge and to avoid selling at what they believe is an unreasonably deflated price is via an earnout. While there are an infinite number of ways to structure an earnout, they are essentially a way of agreeing to pay a vendor a higher final price for their business if the business achieves certain agreed milestones such as a revenue or earnings performance target.

Particularly with the backdrop of an economic slowdown, earnouts can be used to minimise a seller’s downside whilst also rewarding them should the business exceed the current performance expectations of the prospective buyer.

For more information on earnouts, click here.

Going on the offensive

While this post has thus far focused on selling a business during an economic downturn, it is also important to note that recessions also provide business owners with opportunities to themselves grow through acquisition.

For the suitably motivated buyer, a recession can present opportunities to acquire distressed competitors within their industry. It can also create opportunities to engage in acquisition conversations with fellow owners who presently lack “the stomach” to continue operating their businesses through what may be a challenging period.

Clearly, acquiring another business during an economic downturn requires careful consideration and deep due diligence on possible target companies. However, it can be a way of accelerating one’s business and positioning it strongly for when the economy returns to a more buoyant footing.

If you would like to discuss how CFSG can assist you in selling your business or in exploring acquisition opportunities, we invite you to contact us.