How will the 2025 economy and declining interest rates affect small businesses and the M&A market?
Updated December 19th, 2024 after J Powell announced another 0.25% cut in the Fed Rate
As expected, Federal Reserve Chairman J Powell announced another rate cut at the December 17th, 2024 press conference following the Federal Reserve board meeting.
The second half of 2024 has now seen 3 rate cuts by the Federal Reserve, a hefty 0.5% rate cut in September 2024, followed by a 0.25% cuts in November and December. These cuts resulted in the Prime Rate dropping from the 8.5% peak in July 2023, to 7.5% in December of 2024.
Economists and Wall Street were expecting four rate cuts in 2025, however, the December Fed press release indicated only two rate cuts are now expected in 2025 due to projected inflation rate not remaining above the Fed target. Wall Street and the stock indexes had a negative reaction to this as economists had already baked in the 0.25% cut in December but were expecting four cuts in 2025. Consequently the Dow dropped 1,100 points on this news and stock indexes dropped approximately 3% for the day.
This is unlikely to affect small businesses or small business sales and Lower Middle Market M&A transactions. The December rate cut is certainly welcome but business sales transactions have been increasing without the rate cuts. Lower interest rates will reduce the debt costs in small business acquisitions and SBA financing, and should fuel the small business M&A market further.
Read Federal Reserve Official Press Release December 18th, 2024
Read FOMC (Federal Open Market Committee) Summary of Fed Funds Rate Projection
Read CNN Dow Plunges 1,100 points after Fed’s rate December rate and announcement of only two cuts in 2025
Link to chart showing the Historical US Prime Rate from 1947 to November 2024
Source data for chart above JP Morgan Chase Historical Prime Rate
SBA lending and deal-making remained active throughout the post-pandemic rate increases starting in May of 2022 and hitting their peak in July 2023. SBA lending rates have followed the Prime Rate, dropping from a peak of 11.5% (maximum allowed rate) to 10.75%.
While the maximum rate is now 10.25%, few lenders are charging the maximum rate due to the competitive lending market. We expect most lenders to offer SBA loan rates between 10.% and 10.5% variable rates over 10 years. We have one lender offering 10-year fixed-rate loans at 8.0% to 8.5% for qualified buyers and businesses. (these rates vary with the current 10-year treasury rate)
Economists expect another 0.25% reduction in the Fed Funds rate in December 2024, which in turn should drop the prime rate from 7.75% to 7.5% with a corresponding rate decrease expected for SBA loans.
Despite the fluctuating nature of Wall Street during 2024, small and mid-sized enterprises continue to enjoy a prosperous period, with financial metrics, business valuations, and business sale transactions painting a favorable picture as 2024 progresses into 2025. As Orange County and California business brokers, our experience reflects the same trend.
Are there Dark Clouds on the Horizon for US Economy? Will Declining Tax Revenues, Increased Tariffs, and increased National Debt kill the Economic Recovery in 2025 and beyond?
Fed Chair J Powell shared his thoughts recently about the risks of large US budget deficits and increasing national debt.
Powell said, “The level of our debt relative to the economy is not unsustainable. The path is unsustainable. And we see that. And, you know, you’ve got a very large deficit at — you’re at full employment at that’s expected to continue. … It’s ultimately a threat to the economy.”
In addition to the budget and deficit risks, there is a significant risk of increased tariffs resulting from President-Elect Trump’s trade policies. Increased tariffs will likely increase the COGS for companies importing materials and finished goods from China, Mexico, and other US trading partners. In the short term companies importing goods may not be able to increase prices quickly enough to keep pace with the increased costs which could affect profitability. As prices necessarily increase as a result of increased costs of imported goods inflation could be reignited which in turn would cause the Fed to increase interest rates.
At this point, tariffs are difficult to predict. They may not happen at all, or they may be lower than threatened by Trump.
Read more and view charts on The Motley Fool article “Hold Up. Fed Chair Powell Just Issued a Dour Warning on the Economy. Is the Bull Market in Trouble?”
Also, The Motley Fool “Trump Stock Market Rally Is Doomed for This Simple Reason”
BizBuySell 2024 Q3 Market Insights Report: Buyer & Seller Confidence Up, Deal-Making Activity Grows, Manufacturing Values Continue to Increase
BizBuySell released the 2024 Q3 Market Insight report and it’s good news for manufacturing and service businesses. The 2024 3rd Quarter BizBuySell Insight Report shows small business acquisition transactions up by 5% from the same period in 2023 and the fifth consecutive quarter of year-over-year gains. 2023 Q3 estimated transaction values were 20% higher than 2022 Q3. Service and manufacturing are showing solid growth in both values and total transactions.
Buyer and Seller confidence increased from 2023 and estimated total transaction values hit a peak since 2017 with gains in both service and manufacturing sectors.
note: The BizBuySell Insights charts below include data for all transactions, which include a wide variety of businesses ranging from main-street businesses to manufacturing companies.
- Small business acquisitions increase 5% 2023 Q3, the fifth consecutive quarter of year-over-year gains
- 2024 Q3 transaction values were 20% higher than 2023 Q3 and trending upward since 2023
- Buyer & Seller Confidence Index trending up from 2023
- Financial Performance of Sold Businesses continues to trend upward
Total transaction values have been steadily trending up since mid-2023. Businesses that sold in 2024 Q3 had increased revenue and earnings from previous quarters.
While 2024 Q3 total transaction values increased from Q2, the number of transactions had a modest decline from Q2, but increased year-over-year from 2023 Q3.
Median Sale vs Asking price dropped from Q2 but on a steady upward trend since 2022 Q3.
Note that on the BizBuySell.com report the Medial Sale vs Asking Price and Financials of Sold Businesses can be shown by industry by clicking on the Industry drop-down button.
One would expect transaction value by industry and transactions (number of transactions) by industry to roughly correlate, but they have an interesting divergence. Manufacturing represents 16% of transaction value and only 6% of total transactions, while retail & retail-other represent 18% of transaction value and 41% of total transactions. Likewise, all other represents 29% of transaction values and 14% of total transactions.
The explanation is two-fold and straightforward, 1) the population of retail businesses is huge in comparison to the population of manufacturing businesses, and 2) manufacturing businesses tend have higher revenue and earnings plus sell for higher multiples than retail businesses.
2025 US Economy Projections Updated November 2024
The Deloitte 2024 Q3 Economic Forecast provides excellent insights into the 2025 US economy. Deloitte is projecting slowing, but modest GDP growth in 2025 with increasing GDP growth in 2026 through 2028.
- GDP Growth slowing in 2025, but trending up through 2028
- Housing Starts increasing from the decline in 2021 through 2024, and modest growth in 2025 & 2026
- Fed Funds Rate is projected to continue a downward trend through 2027 and level off
- US Government Spending projected to have steady growth through 2028
- Consumer Price and Employment Cost indexes are projected to continue to show lower inflation in 2025 leveling off to normal levels in 2026.
Read the full Deloitte 2024 Q3 US Economic Forecast
2025 Housing starts are projected to increase slightly with investment in private housing increasing. It is important to note that Housing Starts reflects single-family home construction and does not reflect multi-unit, commercial, or home remodeling construction. Thus, the chart below only shows new home construction trends.
Deloitte is projecting a steady reduction in the Fed Funds rate through the end of 2026 which will result in further rate decreases in the Prime Rate and consequently SBA loan rates through 2026. This is good new for buyers and business owners with variable-rate SBA loans.
Government spending is projected to increase steadily in 2025 and through 2028 which should be good news for Aerospace and Defense contractors and manufacturing businesses.
Consumer Price and Employment Cost index increases are projected to continue to slow from the 2022 peak through 2025, leveling off to normal inflation rates in 2026 through 2028.
2025 M&A and Small-Midsize Business Sale Outlook
Transaction volume (number of business sales) and transaction values have steadily increased since 2023. With SBA loan rates dropping and overall business financial performance improving, 2025 looks to be a good year for owners wanting to sell their businesses and buyers looking for businesses to buy.
We expect industrial businesses such as B2B services, distribution & 3PL, manufacturing, and construction-contractor businesses to have an excellent 2025 for business sales (transaction) activity and values. Service businesses such as Plumbing, HVAC, and Electrical were in high demand in 2024 and will continue through 2025 as a result of increased acquisition activity by Private Equity.
Retail, restaurants, and hospitality businesses are still recovering and not expected to see significant increases in deal activity or valuations, but they are recovering and on a slow upward trend.
What does all this mean for Small & Mid Size Business Sales & Business Valuations?
Business valuations are driven by earnings, specifically Discretionary Earnings and EBITDA. While business revenues and earnings vary, the multiples of earnings (DE & EBITDA) do not change much. Valuation multiples vary by industry type and business size, but within an industry, they don’t fluctuate much over time or with the economy. Thus your company value is determined by its financial performance, and not Wall Street or even the overall economy.
As an example, during the pandemic retail, hospitality, and travel businesses suffered greatly, while construction, manufacturing, and industrial businesses continued to thrive and business sales in these sectors performed well during and after the COVID pandemic.
Businesses with good financial performance throughout 2023 and 2024 and going into 2025 can expect good valuations and good demand if they go to market in 2025.
Businesses with declining sales and earnings will be difficult to sell and if sold can expect discounted valuations.
While the above is always true, it is especially true now because of the economy, interest rates, and general concerns about companies recovering from the pandemic and economic turmoil of recent years.
Connect With Orange County & California Business Broker Experts
Pacific Business Sales stands as a leading business brokerage firm headquartered in Orange County, serving clients across California with expertise in both asset sales and stock sales, including businesses with licensing. With a dedicated network of financial advisors and other business consultants, we specialize in implementing tax strategies and deal structures aimed at minimizing taxes on business sales. For a consultation or more information on our services, contact us and speak with one of our professionals today.
