Are you prepared for a downturn? Many may not be

About 1,000 middle-market business executives answered Chase’s 2019 Business Leaders Outlook survey. Here, Steven Faulkner, the Private Bank’s Head of Private Business Advisory, interprets what their responses may say about risks to your business and financial health—if you are a business owner.

Investing in businesses

Finding 1: Companies’ plans for reinvestment do not seem to be in line with expectations for growth.   Only 44% of executives surveyed said they expect to increase capital expenditures in 2019, and only 35% expect their credit needs to increase. Yet 81% anticipate higher revenues and 74% expect higher profits.

Steven Faulkner’s insight: The combination of these findings may indicate reason for concern. Business owners can squeeze out revenue, sales and profits without investing in capital expenditures or using additional credit for a short period. But that is not a sustainable financial model. Typically, you want to invest consistently in your business, and take the opportunity to increase that investment when times are good and revenues are up.

You may not want to wait too long to revisit your capital investments for another reason: tax reform.

The Tax Cuts & Jobs Act of 2017 allows businesses to expense, immediately, 100% of the cost of assets that qualify under the law and are placed in service after September 27, 2017, and before January 1, 2023. But that provision begins phasing out in 2023, decreases by 20% each year, and is almost entirely gone after 2026.

Growth strategies

Finding 2: More than a quarter of business executives said merger or acquisition was one of their preferred growth strategies in the coming 12 months. Many executives also identified acquiring new customers, offerings and markets as additional growth strategies (which are often complementary to M&A).

Faulkner’s insight: Business owners should beware of thinking that acquisition can alter their profit or revenue growth in one year. More than one in four executives surveyed said acquisition was part of their companies’ plans to attract customers, diversify offerings, expand markets and lift profits in 2019. But, of course, companies have to absorb the transaction costs of acquisition before getting to synergies. In my experience, post-merger integration usually takes 12 to 24 months—and sometimes longer.

I’d also advise caution on making acquisitions in what may be very late in the economic cycle. We believe market valuations for businesses have plateaued, making acquisition an expensive way to drive growth. I’d rather be a seller than a buyer in this market. What if the market turns in 18 months? Can you support additional debt service stemming from an acquisition?

If you’re going to acquire, think about building in downside protection in the form of contingent consideration, an earn-out, or requiring the seller to roll equity forward into the deal. Be sure to test the quality of the earnings that an acquisition might bring and, if you can, analyze how the target performed through a previous cycle.

Disruptive technologies

Finding 3: More than half of the business executives surveyed thought their industries were to some degree vulnerable to disruptive technology. Yet less than half thought their businesses were particularly at risk. And 25% said they had not yet taken any action in response to disruptive new technologies.

Faulkner’s insight: Executives may be saying, “My neighbor is at risk, but I’m fine.” That could suggest a potential illusion of preparedness.

We all know that consumer preferences are changing with breathtaking speed, forcing industries to constantly redeploy capital and to reinvent themselves. If your business requires logistics, the Amazons of the world are producing incredible pressures—and opportunities—with their disruption of supply chain, warehousing and distribution. Simply staying vigilant to the increasing sophistication of cyber threats requires discipline and focus.

If you are like most entrepreneurs, you tend to discount or be comfortable with risk. Maybe you’re willing to keep betting it all. But be advised: What works well in the early stages of a company may not work indefinitely. Mature companies are inherently less nimble and tend to adopt a “business as usual” philosophy. Taking no defensive action can be extremely risky.

At the very least, you need to have a formal process to gather the key performance indicators and global trends affecting your business. The survey found 38% of business owners have a designated person or team charged with SWOT analysis to spot potential disrupters and take advantage of market volatility.

Think about how well positioned your business is, and make sure your capital expenditure plan is integrated into your assumptions regarding technological disruption, supply and demand shifts, as well as geopolitical risk—especially in the light of inevitable recession.

Business transition plans

Finding 4: An overwhelming majority of executives say their companies do not have a business transition plan. While fully 68% said the companies don’t have such a plan, another 6% said they didn’t know.

Faulkner’s insight: It may be that owners have not communicated such plans to their C-suites. However, it is our experience that many business owners do not put such plans in place, because they are focused on creating wealth. It is hard to do everything. But every business owner will go through a transition at some point. Not to have a transition plan in place is irresponsible—a failure to take care of yourself, your business, your employees and your loved ones. You want your plan to be optimized: integrated, efficient, accretive and tax-advantaged. Tax considerations are particularly important in the United States, where a failure to plan likely means more of your wealth will go to pay taxes.  

Even if you have no plans to sell or in any way transfer your company in the near term, consider this: A good plan takes time to develop and more time to implement. It is vital to start strategizing two or three years in advance of a transition—at a minimum; ideally, you want five years, especially if multi-generational retention is the goal.

The economic cycle is a critical factor. It looks as though we are currently in the late stages of an economic cycle. And, of course, if you sell during a recession, you’re likely to lose significant value. Buyers will want to see two to three years of revenue and earnings improvement to pay full value for a company. That’s difficult to demonstrate during an economic downturn.

Having a transition plan in place doesn’t require you to sell, transfer or even to know what you’re going to do in five, six or 10 years. It doesn’t lock you in. You can change the plan and the ultimate outcome. You also don’t have to lose control of your business. You can create transition plans in which you still retain control. And sharing the knowledge that a thoughtful transition plan is in place can be comforting to the C-suite, and can avoid the disruption and value diminution that often arise from uncertainty.

Understanding the financial opportunities and costs associated with each strategy can help you select a transition that fits your unique situation.

Options and resources

Make sure that you know all your options, and make the most of your business and personal wealth. Speak with your J.P. Morgan Advisor about how to you can tap into the full resources of our firm. We are here to work to help you and your other professional advisors.

To see the 2019 Business Leaders Outlook from Chase Commercial Bank, click here.

You may also be interested in a report on Gender, Age, and Small Business Financial Outcomes from the JPMorgan Chase & Co. Institute.

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