Maintaining Enterprise Value in a Recession

As published in the Pennsylvania CPA Journal – linked here
​By Rick Calabrese Jr., CPA, LLM (Taxation) 

​Despite an endless supply of prognosticators, the fact is no one knows for sure whether or not a recession is coming. That doesn’t mean business owners and their CPAs shouldn’t take preemptive steps to help combat the negative impacts of a recession should one take hold. Business owners nearing their “exit date” (a sale of their business to retire or enter a new industry) should be especially concerned because of the impact a recession would have on the value of their businesses. Recessions typically align with a reduction in business valuations as buyer demand diminishes and underlying financial performance suffers. Many strategies for weathering a recession require proactive planning. A well thought-out and detailed plan will allow business owners to reframe the potential impact from an existential risk to an opportunity to maximize business value by demonstrating resilience. Business owners thinking about moving on may want to consider taking the following preemptive actions. Reward/retain key employees – Aside from obvious financial metrics (revenue and earnings before interest taxes depreciation and amortization – EBITDA), an important value driver in a business sale is evidence of key employee retention. There are many ways to recognize and reward vital employees other than salary raises or cash bonuses, which can be difficult when cash is tight. Consider other methods to maintain employee loyalty and prevent attrition, such as developing a phantom stock plan or similar equity incentive plan, promotions and added responsibilities tied to documented performance indicators, or noncash perks and benefits, such as additional paid time off. Minimize owner dependence – Buyers are not interested in buying “Commonwealth M&A LLC” per se, but rather a steady, predictable, and (hopefully) increasing stream of cash-flows. Basically, that means businesses whose owners are less involved in day-to-day operations and more involved in high-level activities (drafting/reviewing proposals, marketing, long-term decision making/planning) are more likely to receive a higher valuation than those in which the “owner is the business.” On the television show Shark Tank, Kevin O’Leary frequently asks small-business owners, “What happens if you get hit by a bus tomorrow?” The logic here highlights why businesses with less-hands-on owners command a higher value. Those businesses are less risky and are viewed as more of an investment rather than a job – something almost all buyers have near the top of their checklists. CPAs may find it difficult to convince their clients to let go of day-to-day control, but their clients may reconsider when they are told it will help increase their business’s value. Use recession-driven downtime efficiently – Wisely use any downtime a recession may bring to prepare for an exit. Steps can include documenting business processes, reviewing accounting processes for inefficiencies or errors, engaging M&A advisers and developing a preliminary business valuation, and conducting an internal “self-audit” to help spot issues that may come to light in due diligence. De-risk revenue by extending customer contracts – Consider negotiating term extensions on key revenue-generating contracts. Economic recessions will result in a systemic reduction in discretionary spending, and any added assurance of future revenue will help businesses during an economic downturn. Increase marketing efforts – Increasing costs may seem counterintuitive in a recession, but it can be beneficial to zig when others zag. Per a report by Nielsen Ad Intel, the advertising marketplace in the United States shrank by 7% in the second quarter of 2022 versus the same time the previous year. That being said, most recessions are short lived, with 75% of them ending within a year and 30% lasting only two quarters. Moreover, per an article in the Harvard Business Review, on average, increases in the marketing spend during a recession improves financial performance during the year. Therefore, reductions in marketing may only provide short-term benefits and nominal savings, putting the company at a significant disadvantage heading into the bounce-back period. Instead, use a downturn to gain market share and develop a solid marketing plan while competitors are hitting the stop button. Consider business acquisition to add scale – Larger businesses are more valuable due to a higher basis of cash flow and lower perceived risk of ongoing operations. A recession presents an opportunity to “buy low” and “sell high” when valuations rebound. The lead time to execute an acquisition is significant, though. Waiting for a recession to materialize is too late to capitalize on favorable opportunities. Recessions are unpredictable, but business owners can take control of how they respond and potentially increase their businesses’ enterprise value.