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Inflation’s Impact on Market Transactions

Posted on December 9, 2021 by

Ben Smith

Ben Smith

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As Covid variants continue to challenge the economy, apprehension and marketplace anxiety continues alongside re-opening in some areas.  Re-openings provide more opportunities for consumers to spend money from stimulus payments and low-cost debt. Many believe this will lead to inflationary environments, pointing to the Bureau of Labor Statistics recent reported rise in inflation of 6.2% over the year ending October 2021. These price increases either get passed on to consumers, which inevitably turns some away from a product, or passed on to investors. 

Navigating business transactions in an ever-evolving post-pandemic world has become challenging for entrepreneurs. Those looking to acquire a business must pay particular attention to raw material pricing, watching for margin erosion, driven by inflation in their target’s key product lines and channels. Of key interest is understanding how readily a potential business can respond to and pass cost increases on to customers while maintaining demand levels.   

From a seller’s perspective lack of pricing contracts with suppliers can create uncertainty amongst suitors potentially leading to lower valuations. In addition, as we gain additional financial history once one-time cost increases become more difficult to support.  Ongoing supply chain issues result in both increased material costs as well as increased lead time, on-hand inventory, requiring related working capital investments that will not be recovered by sellers upon exit.  

Not all industries have been affected as severely.  Internet based companies, IT, and communications have fared rather well despite marketplace anxiety.  However, now some are asking whether or how long pandemic fueled demand will continue to lead to steady cashflow.  

While most consider the amount of “dry-powder” – private equity, family office, and independent investor cash waiting to be deployed – available to be sufficient to sustain ongoing M&A activity, it is ever more important to perform robust financial diligence on recent periods.  Buyers must search for evidence of growing trends that may be indicative of a businesses inability to continue operating under current models.  Sellers must have a strong understanding of their current model and it sustainability in order to maintain investor confidence throughout the process. 

Updated from 12.9.2021

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Ben Smith

Shareholder, Consulting

Ben leads the firm’s consulting group, helping middle-market clients optimize results through transaction services and digital advisory support.

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