SMB Market Observer - May 2022

Written by
Tim Ludwig
August 23, 2022
SMB Market Observer

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During the week of April 25, I surveyed members of the small business community1 to get a snapshot of current market sentiment. Some reflections and a selection of the responses are provided in this memo.

This quote from a banker captures the general thoughts expressed by many:

"There is an increasingly uncertain risk outlook… interest rates, inflation, signs of rapid deterioration in consumer spending for non-essential items. Historic performance is no longer the benchmark for future expectations that it once was."

If you’ve ever been on the plains and seen the weather gather at the edge of the horizon and the clouds forming into a low, dark wall moving inexorably closer, you know the tightening feeling in your chest that accompanies a drop in barometric pressure. That’s the image conjured by reading over 40 responses to a few simple questions about life in the domestic small business economy. The bull market of more than a decade – fueled by innovation, generationally low interest rates, and unprecedented printing of greenbacks – may be coming to an end. Or not. I don’t really know, but, despite continued strength in current demand, there are some indicators that the economy could be headed towards a shift away from growth.

What did I ask in my survey? Four simple questions to collect anecdotes and discover patterns from across a representative sample of small business constituents – operators, lenders, brokers, investors, and service providers. The results themselves may not surprise, but the details provide insightful color about an evolving market landscape.

What is your greatest business challenge right now?

The consistency of responses across all sectors and geographies was strong. The number one challenge? Labor, both in terms of the availability of people and the cost to employ them. A close second was supply-chain issues, specifically related to rising costs (and associated margin pressures) and longer lead times. 

On the labor shortage:

  • “Labor remains the number one issue, along with input costs. There is just a lot of uncertainty. Many people felt like once we got past Omicron in early 2022, that we were in the clear – but now the Russia invasion has people on edge.” – Lender
  • “It is very difficult to find enough staff to properly staff our businesses.” – Operator, hotels and construction
  • “Across our businesses, we’re experiencing the highest attrition we’ve seen in years…and we’ve had to raise wages across our companies at every level to retain employees.” – Investor
  • “The availability and quality of low-skill labor is better than 6 months ago but still awful. We can usually build a schedule to be open full hours, but the call-off frequency still kills us.” – Quick-serve restaurant owner

Other topics:

  • “Managing liquidity constraints with the rising commodity prices but fixed revolver capacity is a current challenge.” – Operator, natural resources
  • “Our biggest challenge is dealing with the existential threat of Google’s search algorithm changing in a way that materially impacts our business, given that around 50% of our revenue comes from SEO. I’d imagine a lot of SMBs struggle with a platform or large customer in similar ways and try to diversify. Secondarily, it’s trying to manage a team of individual contributors without a strong management layer. We don’t have the revenues to hire a strong management team, and so a lot of the burden falls to the CEO.” – Owner, online information services company
  • “There are plenty of people looking to sell. We’re having a hard time working seller carry notes with interest rates. Cash is king, for the moment, but plenty of clients are pausing their exit to reassess and reconsidering how much inflation will affect them after they’re out.” – Business broker
  • “Materials – some key supplies are sold out through year end, with no sign of abating. These are custom extruded parts, so we can’t easily substitute in another supplier. Some very small competitors have nearly been wiped out because they can’t manage the working capital implications of carrying so much inventory.” – Owner, manufacturing business

What is going really well in your business?

Many participants reported a strong demand for their products and services while others highlighted the benefits of utilizing technology to drive business performance. Remote work also made an appearance, and it seems that companies are having success in figuring it out and using those policies to mitigate the impact of the labor shortage mentioned above.

On demand:

  • “Demand for our services is steady and requires next to no effort on our part. I have basically no advertising running, and we haven’t attempted to email our prior customers in over a year. Leads just keep rolling in and closing.” – Owner, residential services company
  • “Sales. We’re currently on pace to grow 100% YoY.” – Owner, agriculture industry
  • “We see limited weakness across the industries we serve – our customers have a lot of work.” – Owner, equipment-leasing business
  • “Demand is very robust across our companies, for all sorts of products and services” – Investor

Use of technology:

  • “We implemented a self-serve deal-screening process for pre-LOI deals 1 year ago. It has led to a measurable increase in our capacity and is a better method for us to screen.” – SBA lender
  • “Tech implementation is finally beginning to show signs it will pay off in the long term and help reduce costs.” – Owner, manufacturing company

Remote (and other) work:

  • “We are very strong in training and standard operating procedures. This has been a saving grace in the hiring wars because we can effectively hire more junior than our competition … We are big on creating repeatable processes … to create operational scale.” – Owner, software company
  • “Our team is fully remote and killing it. The culture has gelled, and the team is coming up with good solutions (instead of just pointing out problems) and working as a unit.”    – Owner, marketing agency
  • “We’ve figured out how to hire and retain remote talent really well, which has allowed us to keep costs down and grow the team quickly. There is really strong white-collar entry- to mid-level talent in international markets working for companies that have bad cultures and worse compensation. They are hardworking, diligent, and grateful to work in a company that [utilizes] modern-day best practices for managing teams.” – Software company owner

What new trends have you noticed recently or do you expect to see in the near term?

This question had the least consistency across answers, although some of the earlier themes appeared here as well. Most people mentioned trends specific to their industry, and, as is always the case, markets continue to evolve and create both opportunities and challenges.

  • “Inflation in raw materials is beyond belief. We’re seeing 2–3x the previous cost on lots of items.” – Owner, industrial distribution business
  • “We actually think inflation has been a benefit to us. There's never been a better time to raise prices than now, and you never have an easier built-in excuse than now to go and do it. Across the board. We have been raising prices and been fairly aggressive with it and have gotten limited pushback.” - Investor
  • “The talent market has been frothy, but, with expectations around a recession, I expect that to change, companies to tighten, and less availability for jobs to level the playing field a bit.” – Consultant
  • “I am personally bearish in the prospects for big tech in the near future, particularly in an inflationary environment. Some tech players will go extinct; others will contract. But I do think we’ll see a general cost reduction in our industry. That will happen at the valuation level and also individual software developer salaries. It’s hard to maintain an environment where senior developers on the coasts can make $300K+. Today, they are competing with the entire globe. Additionally, as large techs make cuts, that will throw more quality developer supply into the market, lowering wages. We also believe a number of SMB acquirers have gotten in over their heads with tech.” – Software company owner
  • “Revolver utilization and capex requests have increased. Revolver reasons are a solid ’21 and forecasted ’22 growth combined with increased commodity costs. Capex reasons include labor and supply-chain constraints hurting just-in-time inventory management.” – Lender
  • “Pressures to increase salaries that outpace our revenues.” – Owner, therapy services business
  • “I’d expect acquisition multiples to compress with higher interest rates and a recessionary environment.” – Owner, municipal services company
  • “Inflation. We’re definitely seeing it on the vendor side and continuously asking ourselves how much/how often we can change prices for our customers without hurting them or our business. Honestly, no SMB leader today has led in a world with the inflation rate at this level, so we don’t have a template or best practices. We’re making it up as we go.” – Owner, software company
  • “Not sure how anecdotal this will be, but recurring-revenue businesses aligned with PE-backed roll-ups are getting great valuations; it almost feels like ‘name your price’.” – Business broker
  • “We’re in marketing, so this might be unique to us, but the death of influencer marketing is coming quickly.” – Marketing agency owner
  • “Everyone is stepping up their game in online digital advertising and social media. Companies that refuse to invest in this will continue to concede market share to ones that do.” – Home services company owner
  • “Increasing demand for automation. How do we go and continue to reduce the demand on people, whether it's through processes or a service…how do we reduce them so we don't need as much manpower? So, we are making changes, buying equipment, or implementing things that can reduce or streamline our labor inputs.” - Investor
  • “Offshoring – people costs are so high here and the arbitrage is too big to not take advantage of this. We’re going to introduce it here in the next 6 months.” – Operator
  • “I think smart businesses are going to be looking at more and more ways to reduce the stress – maybe the unintended levels of stress. I'm actually doing some work on the insurance side, and there’s some collaboration from insurance companies and brokers being discussed. But this is mainly a hot topic … because margins continue to be driven up and this is mainly on the backs of people.” – Investor
  • “The most non-obvious one I can give you is the lack of retail space available. At least in my markets, … it is extremely challenging to find good vacant space in almost every sub-market.” – Quick-serve restaurant operator

What are the most common issues voiced by other business leaders in your community?

It won’t surprise anyone that the common refrain here echoed the respondents’ answers to the first question.  Labor, once again, was the most common topic being discussed among peers in the SMB community. 

All things labor:

  • “Labor constraints – turnover, reliability, pressures to increase wages.” – Lender
  • “Some common challenges include hiring and retaining talent in a labor shortage, updating systems to best-in-class SaaS, building a strong supporting cast of managers for the 1-2 people at the top.” – Information services company owner
  • “Talking about hiring is almost cliché, but it continues to be a challenge, particularly for skilled-trade positions. I’ve increased my pay range by 20%, and the applicants still barely trickle in. Related to this, a lot of business owners are having to pass price increases, which is psychologically challenging for owners and also just difficult to convince your salespeople.” – Owner, residential services company
  • “Everyone is having labor challenges. It’s a great time to be an employee!” – Software company operator
  • “Labor shortage. Supply-chain constraints for raw materials … especially when dealing in the spot market for metals-based products (lithium, etc.).” – Natural resources executive
  • “Labor remains the number one thing on everyone’s mind. It’s also not just low skill – area manager roles are super tight and wages have gone up a lot (80K was high-end 2 years ago and today is closer to a floor).” – Quick-serve restaurant owner
  • “Employees – getting good ones, keeping good ones. The smaller niche spaces actually seem to suffer less from this, perhaps because I just happen to be talking with great cultured companies, but I think there is actually some benefit to being in niche technical fields right now in regard to keeping employees (mostly blue-collar stuff).” – Business broker
  • “It really depends on the industry. For those hit hard by COVID, it’s ultimately a demand problem because they got unlucky. For those on the other side (increased demand), finding and retaining employees seems the most common issue.” – Manufacturing company owner
  • “Inflation and hiring. No one can find good talent, and everything costs way more than it did 12 months ago.” – Industrial services business owner

And a few final comments related to the economy:

  • “Recession/retraction – I’m almost certain it’s coming and it seems like that’s becoming the consensus.” – Operator
  • “We are seeing tons of business owners that are interested in selling their business now because they're just tired. They've lived through COVID, they've lived through the recession, and now it's like, okay, here's another challenge in terms of labor, getting products, and inflation and they just kind of hit a wall. Now could be the best time that we see in the next several years to sell because we know that interest rates are going to go up, we know that the good times are not going to last forever.” – Investor
  • “Things are good now, but everyone is worried about what’s coming down the pike.” – Professional services business owner
  • “Sales coming back to earth without continuing stimulus and leveling off of customers for goods but not services.” – Real estate investor and manager

Closing Thoughts

"There's nothing more frustrating to a business owner - and I know this and I know you know it, too - than having the demand there and knowing that you can't serve it. Literally you want to rip your eyeballs out. It's so frustrating knowing that you could probably grow another 10% plus if you just had the people and the materials." - Investor

We are clearly not yet seeing a slowdown in the economy and there is a swirling mix of headwinds and tailwinds right now: labor, inflation, and supply chain issues are real and present, but so is strong demand for products and services.  The music is still playing and people are dancing, but sometimes remotely or in other countries as work-from-anywhere and offshoring become more common tactics to combat rising wages and to attract and retain the scarce talent that everyone is seeking.  Also, the adoption of technology to create efficiencies is increasing and, from personal experience, the explosion of both low-cost low/no-code tools and industry-specific SaaS products is tech-enabling even the most basic industries.  

What wasn’t mentioned in the responses I collected? Crypto, NFTs, SPACs, and other creatures born of exuberance and a speculative, gold-rush mindset. The SMB market is largely defined by real people living off of the real value they create by solving real problems for real customers. That’s why I love it. There’s no BS in working every day to create stable jobs, making a high-quality product, and consistently meeting your commitments to employees, vendors, and customers. There’s honor and dignity in those efforts. So, even if the storm reaches our threshold and the economy takes a turn for the worse, I have faith that the SMB community will be resilient and rise to whatever challenges may present themselves. We will see what happens between now and the next time I reach out to take the pulse of this vibrant community of doers. Until then, keep building.

(1) 42 interviews were conducted, representing over 31 industries and 32 business owners, three investors, three lenders, two service providers, and two who declined to report their role.