Back in my college days, I had a great economics professor named Dr. Farrokh Nourzad.  In my advanced macroeconomics class, I can still remember the lecture where he talked about inflation and how the media makes it worse by talking about it.  “If everyone thinks inflation is 2%, then it will be 2%.  But the media reporting on inflation makes it 3%!”  I have very fond memories of my classes with Dr. Nourzad, but today, I’m going to disappoint him because I’m going to talk about inflation.  My reasoning?

Inflation creates opportunities for business owners.

Valuation in M&A

What are some of the effects of inflation on businesses? The valuations of most businesses will decrease, and the expected selling price will go down.  Please note that this change has nothing to do with the fundamentals of a business.  It has everything to do with potential buyers having less cash to spend on deals.  From the perspective of the business owner, this can be either be a good or a bad thing.  If an owner truly wants to sell their business, it likely will take longer to identify the right buyer that can offer a fair price in an inflationary environment. However, if someone wanted to grow their business through acquisition, there are going to be some good deals to be had.

Business Planning

We understand how inflation affects business valuations.  But is there an opportunity during this environment?  Short answer, yes.  The opportunity is for the owner to be more diligent in their business planning.  It is a crucial time to plan out different scenarios involving cash flows.  Inflation is going to stress both the revenue and cost side of a business.

For most businesses, they are going to be in a squeezed[1] cash position at the onset of inflationary conditions. The challenge is how quickly can a business increase prices to offset their cost increases.  For businesses where their revenue comes from fixed price contracts, this challenge will significantly impact their bottom line.  For other businesses that have more dynamic pricing flexibility (web retailer for example), increasing prices may be as simple as updating a spreadsheet.  More importantly, possessing the knowledge and financial acumen to model those scenarios and calculate its impact on EBITDA is a clear advantage.

Opportunities abound for business that have saved for a “rainy day”.  Inflation creates opportunities for capital projects that reduce headcount.  Given the difficulty in retaining/hiring employees as well as rising wage expectations, automating tasks through technology does more than just improve EBITDA.  It will also command a higher multiple when trying to sell the business.

Estate & Succession Planning

There is little doubt that inflation, and the market volatility that follows depresses not only the stock market but also the values of privately held businesses.  When these conditions subside, the valuations return, and investors are typically rewarded for long-term holding strategies.

For privately held business owners with succession planning in mind, market dips create opportunities to move shares to the next generation of leaders as well as family members at a discount to “Bull-Market” valuations.  Combining the 20% drop in the S&P 500 over the first two quarters of 2022 with traditional discounts available to privately held companies, shares can be moved to the next generation of leadership at steep discounts to the values that would have existed only six months earlier.

Conclusion

Inflation can create fear and uncertainty for a business owner.  It can also, however, create opportunity from what is widely seen as a negative circumstance. Similar to what many businesses did during COVID, one can choose to view this situation in a positive light and use it as an opportunity to acquire a business at a time of depressed valuations, make their business leaner and stronger for the future, or additionally, strategically leverage inflation to optimize estate planning.  While I may have already broken Farrokh’s rule about publicly talking about inflation, even he would agree that there is no harm in planning for inflation, and he would certainly agree with leveraging it for your business’ and personal advantage.

Franklin Nova Group’s Business Advisory Practice

As trusted consultants, Franklin Nova understands what drives value within a specific phase of a company’s lifecycle.  Regardless of business type or transaction size, or whether the need is ongoing or in support of a single engagement, our value comes from our ability to equally understand the needs of the boardroom – and the shop floor – to see the full context of a business and develop solutions tailored to those specific requirements.

Our experts advise clients in navigating the challenges that come with establishment of a brand, the operational needs of proper marketplace positioning, business growth, monetization of intellectual property, or potential acquisition – always with a focus on optimization of value.

[1] Not a technical or academic term.  If it does become one, I would like to receive full credit and all its glory.