SMB Market Observer - Q2 2022

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During our last quarterly report, we hadn’t yet officially entered a recession, though there were signs we were likely to find ourselves in one soon.  Depending upon whom you ask, we may still not be in a recession; however, by using the traditional definition of a fall in GDP in two consecutive quarters, we’re there.  As you’ll see in the chart above and some of the commentary that follows, this is a strange environment that combines some positive signals (strong demand) along with some countervailing pressures (inflation, labor shortages).

If I were going to summarize the common themes of what you are about to read, it would be look very close to this quote from one of our respondents:

[These are] our clients' four major issues - labor, supply chain, inflation and increasing borrowing

So, with that, let’s dig in and review the highlights to each of the four questions asked in our survey!

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What is your greatest business challenge right now?

Just like last quarter, the number one challenge facing the small business market is labor.  Over 40% of respondents cited some aspect of the labor shortage as their most significant issue right now.  Following just behind the labor issue was inflation, which also showed up in the form of rising wages.  About 17% of people surveyed cited this as the primary problem affecting their business.  

On the labor shortage:

• “Our greatest challenge remains labor. We still need more salespeople and portfolio managers for our anticipated growth.” – Lender
• “Labor, managing working capital, and scaling our business are our issues.” – Operator, home services business
• “We struggle with finding well-trained labor.” – Professional services company CEO
• “Hiring”, “Labor”, “Labor shortage” – Various, cited multiple times

On inflation:

• “Rising costs and wages.” – Operator, IT managed services
• “Rising input costs.” – Operator, food manufacturing
• “Increase in COGS.” – CEO, food services company

Other answers:

• “We are still seeing supply chain and raw material shortages.” – Operator, chemical distribution
• “Prioritizing – lots of deals coming in, but with a lower percentage closing.  Deciding which deals to invest time and energy into is more challenging.” – Lender
• “Long lead times in the semiconductor industry slows our sales cycle from three months to 9-12 months.  This, in turn, slows our top line growth.” – CEO, Technology hardware business

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What is going really well in your business?

Also similar to last quarter, demand appears to remain strong across industries and geographies with over 50% of survey takers reporting sales as the best-performing aspect of their operation during the last three months.  There were also a few mentions of companies benefitting from their ability to increase prices (and profitability) due to material and labor shortages in their markets.

On demand:

• “Top line growth.” – Owner, special events company
• “The fulfillment side of our business is grooving right now.” – CEO, recruiting firm
• “Positive year over year transaction growth.” – Restaurant operator
• “Plenty of demand.”  – Operator, construction company
• “Demand is very high and we’re better at the key constraint (hiring) than our competitors.” – CEO, security services firm
• “Demand for our apartments is at an all-time high.” – Owner, real estate investment firm

Other answers:

• “Our loan growth is really solid. Revolver utilization is up and we have seen about 30-40% of our book request revolver increases to accommodate larger inventory levels (both price and volume). M&A has slowed but remains strong so acquisition financing activity is still there. Debt for capex has been strong too, but has been slightly delayed - we have a lot of approvals for capex financing but supply disruption is slowing down delivery.  Our loan book is incredibly solid with minimal non-performing and watch credits. We are seeing a slowdown in retail and someone off industries, but the rest of our clients are doing quite well despite the headlines.”  – SBA lender
• “High velocity of LOIs.” – Investor
• “Quality referrals driver by relationships.” – Partner, accounting firm
• “We've recently been able to attract really strong talent to lead specific new markets across the US” – Operator, home services business
• “Shortages have increased profit margins.” – Investor

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

The responses to this question typically generate the greatest variety of responses.  This quarter’s survey is no exception.  There was some interesting commentary on the capital markets as well as some indications of an improving supply chain and softening labor market, both of which are new since last quarter.

On capital markets:

• “Leverage appetite is coming down and so are bank hold levels.  Asset based lending is making a comeback.  It is still TBD on purchase multiples for M&A – a lot of capital out there, but if debt levels come down, we could see decreased purchase price multiples…but we’re not seeing that yet.” – Commercial lender
• “More creative capital will likely be needed between senior debt and equity.” – Investor
• “We are seeing more deals break. Sellers may need more time to accept that market conditions have changed given the economic outlook.” – Lender
• “Lenders are seeking lots of equity.” – Private equity partner

On the workforce:

• “Offshoring talent,” “Remote-first hiring”– Various
• “Remote work leading to higher cost of living (COL) in low COL areas.” – CEO, utility infrastructure business
• “It feels like the labor market is starting to loosen slightly.” – Operator, Construction company
• “Employers terminating underperforming staff that were hired out of desperation. They are feeling confident that they can find more qualified replacements.” – CEO, IT solutions company
• “Staffing is becoming easier.” – Healthcare CEO
• “We continue to see robust demand and a competitive recruitment landscape for workers in the entry-level to mid-level roles we recruit for.” – CEO, recruiting company
• “Big tech companies are hiring more slowly.” - Investor

Other answers:

• “Supply is catching up with demand.” – Powersports retailer
• “The supply chain is normalizing for our customers.” – Partner, professional services firm
• “Inflation is becoming a larger part of how we price, how much we pay our people, and the cost of the products we use.” – Operator, waste management business
• “It will be interesting to see where our price increases, which mirror our increase in COGs, meet resistance. We haven’t found it yet!” – CEO, food services company
• “Our percentage of accepted estimates has dropped. It is hard to tell if that is seasonal or a trend of people becoming more careful with their spend.” – Operator, home services company
• “The cost of capital is rising and cash generation is key.  Growing, high cash flow, stable and consistent companies will win back talent faster than their competitors.” – CEO, healthcare services company

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

Many of the issues raised in the first question reappear here in different forms.  We see labor shortages, inflation, and supply chain issues as the predominant themes.

On labor issues:

• “Labor shortages are persisting and disproportionately impacting lower-wage, lower-skilled work forces.” – Banker
• “People are still expressing concern over finding good workers.” – Operator, remediation services
• “Return to work has been challenging. Our corporate leaders are losing their minds on how best to manage their workforce. But with such labor tightness, they can only push so far.” – Partner, finance firm
• “Onboarding new staff in a hybrid environment is new and challenging for many leaders. Needing to allow work from home to be competitive, but finding it more challenging to integrate these new staff members remotely.” – CEO, technology services firm

On inflation:

• “I’m hearing from people in physical products businesses that it is tough – inflation plus supply problems” – Investor
• “There is a lot of chatter about recession fears, inflation fears, and a shortage of workers.” – Broker
• “Inflation is hitting employees in their own lives (more so than the companies in our industry). Some companies tied to consumer discretionary spending are starting to see business slow down.” – CEO, professional services firm
• “We often hear about rising wages and their impact on hiring and retention.” – Operator, staffing and recruiting firm
• “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

Other answers:

• “In manufacturing, people are mostly talking about input costs - suppliers are adding additional costs and we don't know whether they are temporary or going to stay. Also, the combination of Trump-era 'China' tariffs and delays of sea freight are making us all rethink our onshore vs. offshore manufacturing strategy.” – CEO, manufacturing company
• “We are hearing about more customers stretching their payments.” – Operator, construction company

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Closing Thoughts

Anecdotally, the responses to this quarter’s survey expressed less emotion – both positive and negative – than they did in last quarter’s report.  Perhaps things felt more in flux and uncertain a few months ago than they do now?  People could also be more settled and expecting more of the same in the coming weeks than was the case in March and April?  Regardless, the persistence of certain trends – labor and supply chain issues, inflation, robust demand, etc. – are clear, but with some occasional signs that at least some of the challenges may be abating at the margins.  We’ll see if this becomes more pronounced in our next survey.

Among the SMB respondents we surveyed, this was a quarter of many questions. “How long will demand last?” “Will rising rates impact valuations?” “When will the labor market loosen up?” And perhaps most tellingly, “What’s a recession?”