Business owners often ask me “When is the best time to sell my business?” They believe that timing is crucial to maximizing their returns. In this blog, we’ll explore how understanding the business cycle can help you make an informed decision about when to sell your business.

Understanding the Business Cycle

The business cycle can be likened to a clock with four main phases: Expansion, Slowdown, Contraction, and Recovery. While the length of each phase can vary, it’s essential to recognize that predicting market shifts precisely is challenging.

Key Points to Remember:

• Some businesses thrive during economic downturns, while others remain consistent regardless of economic conditions (e.g., discount retailers, healthcare, utilities).
• Multiple cycles can impact your business at the same time, such as seasonal trends or election cycles.

The Four Phases of the Business Cycle

Expansion Phase (9 o’clock)

In the expansion phase, the economy is on the upswing. If you are like most businesses, you will see an uptick in revenue and profits. Economic expansion in New Zealand is associated with improving farm-sector activity and prices, and increases in exports. This feeds into higher levels of consumer confidence and spending. Market demand increases in most industries. Banks are more willing to lend in the small business space, enabling businesses to expand. Fewer businesses fail, and the number of receiverships drop.

Unless you are in a hypercompetitive market, competitive rivalries are quite low during this phase. It is easier for all the market participants to grow by attracting new customers to the market as opposed to try and churn them from competitors. There are fewer bargains to be found in the market – no one needs to discount to make budgets.

Slowdown (12 o’clock)

When we get to the 12 o’clock position, we are at the market peak, and the market then starts to cool. In many cases, the market slowdown is not initially felt in many industries, and most markets remain strong through this phase. The markets are no longer growing, but they are also not contracting appreciably – at least at the start of this phase.

Inflation is a common issue in this phase, which eats away at consumer confidence and spending power. Revenues and earnings start to decline, and firms start focussing on their working capital and internal cost structures: efficiency initiatives start, and there is a clampdown on customer credit. Competition noticeably increases, which puts pressure on prices. Firms start having sales to make quota. Business financing gets tighter. Central banks increase interest rates to counter inflation.

Buyers start looking for ways to cut costs, seeking out commodity pricing where available, and are more likely to change vendors to make a saving. The savings start with the ‘low hanging fruit’ but can progress to reducing staffing levels, renegotiating contracts, or delaying capital expenditures. Vendors tend to increasingly rely on customer relationships.

Contraction (3 o’clock)

Between 3 o’clock at 6 o’clock, the market is contracting. Recessionary pressures emerge. The belt-tightening gets notched up. If inflation is not brought under control, there is a risk of stagflation.

Consumer spending drops as remaining confidence continues to decline, or a higher percentage of spending is committed to staples. Discretionary spending is reduced. Overseas travel, house improvements, and other big-ticket items are delayed. Increasing numbers of consumers have difficulty paying their mortgage and other bills. Credit defaults increase.

Business investment declines. Revenues continue to drop, and profits are thin. Cash flows are strained. Credit dries up. Financial stress increases. Competition intensifies. Inefficient firms in the industry may start to fail. All firms are focused on cutting costs through redundancies, reconfiguration, and delayed capital and operational expenditure. Many firms reduce R&D and marketing.

At an extreme, the government may step in to alleviate the pain. Taxes (e.g., fuel taxes) may be reduced. ‘Pump priming’ initiatives start – large, targeted government expenditure on key infrastructure projects to pump liquidity into the market. Businesses may receive emergency funding or even bailouts.

Recovery (6 o’clock)

It is 6 o’clock. Coming out of the trough marks the end of the downturn. Things stop getting worse, and ‘green shoots’ of new economic activity start to emerge. Business and consumer confidence starts to improve. While things aren’t better yet, new hope can be seen on the horizon. There is a high degree of economic optimism.

Customers become more willing to engage with businesses, and even start buying. Consumer finance eases up. Badly-hit consumers have a chance to catch up on credit payments.

Businesses plan their next expansion as the financial pressures abate. They look for new opportunities to capture market share, plot strategic expansion initiatives, and may also start looking at various forms of diversification. Firms that were badly hit in a particular market view diversification as a risk reduction strategy. Employers focus again on employee retention, just as new employment opportunities emerge. As revenues and profits start increasing, firms restart delayed capital maintenance and expenditure, and rebuild their working capital and reserves. They are willing to extend credit again to capture new customers.

The government, after patting itself on the back for fixing the economy, eases off the big infrastructure projects.

And the market keeps turning. We are back at 9 o’clock. Rinse and repeat.

Timing The Market

So, how do we use this to inform our ideal exit timing?

The notion of timing the market implies two things. The first is that there is an optimal time to sell you business. And in general, there is. The second is that you can plot a predictable timeline to be in the right place at the right time. And this is where is can fall apart.

All other things being equal, the best time to sell is at 11:59, i.e., immediately before the top of the market. The market is strong, and many will believe there is plenty of growth left to exploit. Buyers are eager to invest.

In reality, few can get the timing perfect.

The main problem is you don’t have a lot of control over when a deal will close. Where you do have control is when to start marketing your business. Deals take time to run their course: To find potential buyers, get them interested, do due diligence, and finalise the contract.

To optimise your sale price, you need to be ready to go to market well before 12 o’clock. Selling a small business generally takes three to six months in New Zealand. You need to factor this into your timing. Unfortunately, the investment clock is not predictive. We often don’t know where we are on the clock until afterwards. We also can’t predict how long it will take to get from the 9 o’clock position to 12 o’clock.

The type of buyer you want to target can also impact timing. If you are best served by selling to a competitor or someone moving into our market (e.g., through their diversification strategy), You want to be in the market during the recovery phase. If the likely buyer is an individual, you need to demonstrate strong recent performance, so early in the expansion phase works best.

I find this can best be illustrated with a seasonal cycle. This is a very predictable, timable cycle. If your peak revenues are in the months leading up to Christmas, you want to start marketing your company in July or August. This way, as you complete each month’s reports and provide them to the prospective buyers, the month-on-month results are showing improvement. Buyers like that. These results encourage them. Waiting until Christmas to sell your business means – in most cases – the month-on-month results are now decreasing. As the owner, you know this is expected, so it doesn’t alarm you. Potential buyers won’t generally have the same understanding. They will worry the firm is on a downward slide, and may either back away or try to talk the price down.

The Same Market Argument

Housing prices also go through the same boom and bust cycles. Real estate agents will advise their clients to ignore them because ‘you are buying and selling on the same market.’ This makes some sense. As long as you buy and sell in the same market without much of a gap between. Some try to game the system. When the market is going up, they buy a new house with a long settlement, and sell their current house (they hope) at a higher market level a few weeks later. No guarantee of success, but there will always be people trying.

Of course the ‘same market’ argument doesn’t make sense if you are a property investor or moving overseas to a different market

Business brokers try to use the same market argument. When I was a business broker in Auckland, I was told to use that same line. Why? Because a business broker needs inventory to sell, and can’t wait for the market to be in the right place for you to sell. They want their commissions now!

The other part of the argument from brokers is the certainty of now versus the uncertainty of the future. This has some truth to it – although highly subjective, and still a bit self-serving. The market disruption due to the COVID lockdowns illustrate this point perfectly. Those that held off selling in 2019, trying to time the market, may have been wiped out by the lockdowns and lack of travel. At the very least, the unforeseen circumstances negatively impacted almost every business. Even if you weren’t impacted, there were long periods you couldn’t meet with a broker to have your business assessed and listed, and getting buyers through to view was all but impossible.

And if you are selling your business to buy another, this can all be the right advice. But for many business owners, they have no intention to buy another business. They are planning to start a new business, travel, or retire. There is no ‘same market.’ For these business owners, getting the best price is critical. If they can be patient, they want to try and time the market.

The Risky Downside

So, you decide to try and time the market just right for your exit. What can go wrong?

The major risk is that future uncertainty, that another market-wide disruption comes around. If you are not willing to take the risk, then don’t. Sell as soon as you have the business ready for exit.

Another risk is that you miss the window. You list at 9 o’clock on the hope you’ll get a 10 o’clock or 11 o’clock price. You find a buyer, and negotiations drag out. Due diligence takes longer. And before things are finalised, the market turns and the buyer pulls out. You have already done all the hard work, have the business being marketed with a broker. Do you withdraw and wait for the cycle to come round again? Or do you sell for a discount that reflects the current market? If you are early enough in the slowdown, I would suggest you press on. If you can close the deal before 3 o’clock, you will still probably get an OK deal. If you can’t afford to wait, then press on.

Unless you have to – or have a counter-cyclical business – try and avoid the contraction. Any buyers here are likely to be bargain hunters (or the occasional corporate refugee who has been made redundant). There will be better times ahead to get a higher price.

Conclusion

Yes, timing is everything when it comes to exiting your business. Trying to time your exit to maximise your price can be risky. But it can be done. Start by understanding the market cycle and the impact on your business. With this, you can make better timing decisions if you can be patient.

Also keep in mind the bigger picture. The key to successful exit planning (through selling your business) is to align your exit timing with both market conditions and your personal goals.