Elsevier

Business Horizons

Volume 65, Issue 5, September–October 2022, Pages 617-630
Business Horizons

Selling a business after the pandemic? How crisis and information asymmetry affect deal terms

https://doi.org/10.1016/j.bushor.2021.08.003Get rights and content

Abstract

Prepandemic, small business exits were expected to increase dramatically owing to pent-up supply and the aging business owner population. COVID-19 may have dampened those expectations because of increasing information asymmetries that limited selling options for the small business owner (SBO). SBOs exit for many reasons (e.g., illness, family, retirement), so postponing a sale may not be a viable option. Alternately, SBOs can absorb crisis uncertainty by accepting different deal terms. We propose that one such strategy is to include seller financing as part of the deal terms, thereby signaling to the acquirer the SBOs’ confidence that the purchase is sound. We examine the results of 1,909 exit transactions from both before and after the financial crisis of 2007–2009 and over a 10-year postcrisis horizon. We find that sellers accept a lower price and less favorable terms with increased seller financing in the 24 months postcrisis, and that waiting longer to sell after the crisis improves deal terms for sellers, as this affords SBOs time to exit. Additionally, reduced information asymmetry improves deal terms. Finally, we provide strategies for SBOs to lower information asymmetry in small business exits.

Section snippets

Challenges to selling a small business

Is this a good time for small business owners (SBOs) to consider selling their business? Now that the pandemic shows signs of recovery, SBOs may be wondering when they should sell their businesses and what they can do to get the most favorable outcomes. Certainly, managing a business through this period may have prompted more owners to consider a sale, but even prepandemic, business exits were expected to increase dramatically due to a pent-up supply of businesses and the aging business owner

The role of seller financing in small business exit deal terms

Two strategies used to minimize small business acquisition risk are to seek a lower sale price and to incorporate seller financing as a component of the transaction. A lower asking price compensates for the risk of information asymmetry by providing a cushion for acquirers. Earnouts—the contractual agreements between buyers and sellers, with a portion of the deal consideration being withheld until prespecified performance objectives are met—provide a solution to problems of information

Information asymmetries related to acquisition deal terms

Akerlof (1970) points out that information asymmetry relates to quality and uncertainty. When information asymmetry exists, assets of higher quality are grouped with those of lower quality, making it difficult to distinguish between the two. Information asymmetries also exist because acquirers may not be privy to all the seller’s previous actions and financial records. For example, a seller may have engaged in earnings manipulation by altering financial reports (Healy & Palepu, 2001). The food

Methodology for evaluation of deal terms pre- and postcrisis

To answer our research questions, we analyzed the details of food service business transactions from a privately held business transactional data set (Business Valuation Resources, 2019). Transaction details within the database are obtained through a contributing network of business brokers and merger and acquisition advisors, as well through documents published by the U.S. Securities and Exchange Commission. This data of completed transactions is compiled by the database publisher, Business

Findings of the deal terms

Our research demonstrates that during and after crises, substantial differences in exit price and debt terms exist in the sale of privately held businesses. Much of this is caused by information asymmetry. As such, we provide several evidence-based recommendations for SBOs.

Summary

Our study offers new insight on how crises impact exit value and the selling process involving small businesses. Our findings can inform SBOs about the concepts surrounding pricing, deal terms, and in particular, seller financing. Information asymmetry plays an important role in small business M&A transactions, especially in times of crisis. We draw on the GFC as a guide to understand the potential effects on exiting SBOs over the next decade. The immediate crisis response includes lower

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