Recessions Are Coming - Exit Planning in Uncertain Markets

The question isn’t whether a recession will come—it’s whether you’ll be ready when it does. Business owners who’ve spent years building valuable companies often find themselves paralyzed at the first whisper of economic uncertainty, caught between the fear of selling into a downturn and the risk of waiting for conditions that may never materialize. The owners who navigate these transitions successfully understand how recessions affect lower middle market transactions and build exit strategies that account for economic reality, though understanding alone cannot guarantee favorable outcomes when business fundamentals or market conditions work against them.

Executive Summary

Economic uncertainty creates both risk and opportunity for lower middle market business owners planning their exits. While recessions do impact M&A activity, reducing deal volume and compressing valuations, the effects vary dramatically based on industry, company resilience factors, and deal structure. Understanding these dynamics enables owners to make more informed decisions about exit timing rather than reactive ones driven by fear or speculation.

This analysis examines how recessions affect the key variables in lower middle market transactions: valuations, deal volume, buyer behavior, and financing availability. We identify the company-specific factors that determine resilience during downturns and provide decision frameworks for owners navigating uncertain conditions. The evidence suggests that for well-prepared companies with strong fundamentals, recession-era exits can often achieve acceptable outcomes, though typically with valuation discounts of 15-30% and modified deal structures compared to strong market conditions. The greatest risk often lies not in market timing but in inadequate preparation regardless of economic conditions.

The goal isn’t to predict the next recession or time the market perfectly. It’s to build an exit strategy robust enough to succeed across multiple economic scenarios while positioning your company to capture maximum value whenever you choose to transact. However, we should be clear: understanding recession dynamics is necessary but not sufficient for a successful exit. Business fundamentals, valuation positioning, and timing circumstances all play critical roles that no amount of preparation can fully overcome. For owners with fundamental business weaknesses, structural customer concentration, secular industry decline, or insurmountable owner dependence, preparation may improve but cannot guarantee outcomes.

Introduction

We’ve worked with business owners who sold companies during the 2008 financial crisis, through the COVID-19 disruption, and during every economic wobble in between. The pattern we’ve observed is that owners who understand how recessions affect their specific transaction context, rather than relying on general market sentiment, tend to make more informed decisions. However, our observations necessarily draw from companies that successfully completed transactions with our guidance. Owners who couldn’t find buyers or abandoned processes due to unfavorable terms represent outcomes we see less systematically, which means understanding alone doesn’t guarantee favorable results.

The lower middle market, which we define as businesses with enterprise values between $5 million and $50 million, operates differently than the broader M&A landscape that dominates headlines. When financial media reports major deal volume declines, they’re typically discussing large-cap transactions driven by public market sentiment and institutional capital flows. The lower middle market responds to different dynamics, primarily driven by private equity dry powder, strategic buyer acquisition strategies, and individual buyer motivations that persist, though often diminished, during downturns. This generally applies across industries, though technology companies often behave more like larger markets, and heavily regulated sectors have unique dynamics worth analyzing separately.

This distinction matters because the advice appropriate for a Fortune 500 divestiture differs fundamentally from guidance for a $15 million manufacturing company or an $8 million professional services firm. The factors that drive your company’s value in a recession, recurring revenue, customer concentration, management depth, operational resilience, are largely within your control, even when macroeconomic conditions are not. That said, some factors, like industry cyclicality or concentrated market structures, have real limits to what owners can change within typical exit planning timelines.

Economic cycles are inevitable. Every business owner who plans to exit within the next decade will likely navigate at least one period of significant economic uncertainty. The question isn’t whether you’ll face challenging conditions—it’s whether you’ll have the information and preparation needed to respond strategically rather than reactively. That preparation starts with understanding what typically happens to lower middle market transactions during recessions, while recognizing that every cycle brings its own unique characteristics and that historical patterns provide context but cannot predict timing or magnitude of future market changes.

Historical Lower Middle Market M&A Patterns Through Economic Cycles

Examining lower middle market M&A activity across recent economic downturns, including the 2001 dot-com recession, the 2008-2009 financial crisis, and the 2020 COVID-19 disruption, reveals patterns worth understanding, though with important caveats about data limitations and cycle-specific variations.

Deal Volume Contraction and Recovery

Deal volume in the lower middle market typically contracts during recession periods, though the magnitude varies significantly across cycles and data sources. Industry reports from private equity research firms indicate substantial volume declines during the 2008-2009 period, with variation by sector and transaction size. PitchBook’s U.S. PE Middle Market Report (Q4 2009) documented significant year-over-year declines in middle market deal count, though exact percentages vary depending on how “middle market” is defined and which transaction types are included.

The 2020 COVID-19 disruption produced sharp initial declines. According to Refinitiv data, global M&A volume fell approximately 50% in Q2 2020 compared to Q2 2019, though lower middle market recovery occurred unusually quickly due to unprecedented fiscal stimulus and pent-up buyer demand. By Q4 2020, deal activity had rebounded significantly in many sectors.

It’s important to note that different data sources define “lower middle market” differently, and transaction databases capture varying percentages of actual deal flow. The International Business Brokers Association and similar organizations track smaller transactions that may not appear in institutional databases. This means any specific percentage cited should be understood as directional rather than precise.

What we can say with confidence is that deals continued to close even during severe contractions, though with an important caveat about which types of businesses actually found buyers. Strategic buyers with strong balance sheets maintained acquisition activity. Private equity firms with committed capital continued deploying it, though often more selectively. Individual buyers and search fund operators continued pursuing acquisitions, particularly for smaller transactions. Companies with cyclical revenues, concentrated customers, or owner dependence faced significantly greater difficulty finding buyers, and many would-be sellers either abandoned processes or accepted terms substantially below initial expectations.

Valuation Compression Patterns

Valuation multiples in the lower middle market compress during recessions, but the compression is neither uniform nor universal. Based on GF Data’s analysis of private equity transactions and similar research, well-prepared companies with strong fundamentals typically face valuation discounts of 15-30% during downturns, though this range widens significantly based on:

• Cyclical industries tied to consumer discretionary spending or construction, which often experience the steepest declines (sometimes 40%+ compression)
• Companies with significant customer concentration, where buyer risk perception increases substantially
• Businesses dependent on commodity pricing, which face both operational and valuation pressure
• Firms with high debt or thin operating margins, where recession stress tests viability

Conversely, companies in essential services, healthcare, government contracting, and other recession-resistant sectors have historically maintained valuations better during downturns. The 2020 period saw certain sectors, technology services, e-commerce enablement, healthcare IT, achieve premium valuations even as other sectors contracted significantly.

The practical implication is that industry positioning and company-specific factors often matter more than general economic conditions. A well-positioned company in a resilient sector may achieve a better valuation during a recession than a poorly positioned company during a boom. However, owners should be realistic: if you operate in a cyclical industry with concentrated customers and debt, recession-era valuation compression may be substantial regardless of preparation quality.

Buyer Behavior Shifts During Downturns

Recessions appear to reshape the buyer landscape, though the patterns we observe may reflect both genuine behavioral changes and composition effects, meaning the mix of active buyers shifts rather than individual buyers necessarily changing their approach.

Strategic Buyers who remain active during downturns tend to be those with strong balance sheets and genuine strategic needs. Anecdotal evidence from M&A advisors suggests their focus often shifts toward capability additions, geographic expansion into defensible markets, or vertical integration that reduces supply chain risk. However, many strategic buyers pause acquisition activity entirely during uncertainty, meaning the observed “selectivity” may partly reflect survivor bias among the most committed acquirers.

Private Equity Buyers face conflicting pressures during downturns. According to data from Preqin’s Global Private Equity Report, firms with recently raised funds maintain pressure to deploy capital, while firms mid-fund-cycle may slow activity to focus on existing portfolio company management. Financing constraints tighten as lenders become more conservative, shifting deal structures toward more equity-heavy transactions. Research from Cambridge Associates’ PE benchmark studies suggests that vintage years including recessionary investments have historically shown strong long-term returns on average, though this doesn’t mean every recession-era deal succeeds, and the data reflects aggregate performance rather than individual transaction outcomes.

Individual and Search Fund Buyers present a mixed picture. Their personal motivations, achieving business ownership, building wealth, gaining professional autonomy, don’t diminish during recessions. However, their financing options narrow significantly during credit contractions, potentially limiting both the number of active buyers and the deal sizes they can execute.

Financing Availability and Deal Structure Implications

Perhaps no factor affects lower middle market transactions during recessions more than financing availability. The credit markets that enable acquisitions tighten during economic downturns, reshaping deal structures and shifting negotiating dynamics in ways that directly affect sellers.

Senior Debt Contraction

Traditional bank financing for acquisitions contracts substantially during recessions. Loan-to-value ratios decline, coverage requirements increase, and many lenders pause new acquisition financing while managing existing portfolio stress. Federal Reserve data from the Senior Loan Officer Opinion Survey showed that during the 2008-2009 crisis, approximately 80% of banks reported tightening lending standards for commercial loans, with similar patterns during the initial COVID-19 period.

For sellers, financing contraction means buyers may not be able to execute the fully financed transactions that characterize strong markets. All-cash strategic buyers gain relative advantage. Private equity buyers shift deal structures toward more equity and less debt, affecting their return calculations and potentially their willingness to pay premium valuations. The practical result is often either lower purchase prices, more creative deal structures, or both.

SBA Lending Considerations

Small Business Administration lending programs may offer relatively more consistent availability than conventional bank financing during uncertain periods, though this observation comes with caveats. SBA 7(a) loans can support acquisitions where the business purchase price justifies the loan amount under current SBA guidelines, typically in smaller lower middle market transactions. Competition for SBA financing also increases during credit contractions, potentially offsetting availability advantages.

For owners of smaller lower middle market companies, understanding SBA-eligible transaction structures is worthwhile, though owners shouldn’t assume SBA lending will be unaffected by severe economic disruption.

Seller Financing Expectations

When third-party financing becomes constrained, fewer all-cash transactions occur, and seller financing becomes more prevalent among completed deals. This may reflect genuine buyer demand shifts, but it also likely reflects selection effects: buyers who can’t access traditional financing either drop out of the market or require seller participation to complete transactions.

Owners planning exits during uncertain economic periods should understand seller financing mechanics thoroughly:

• Credit risk: You’re essentially becoming a lender to the buyer, with default risk if the business underperforms. Default rates on seller notes during recessions have historically exceeded 15% in some studies, though data is limited.
• Security interests: Seller notes should be secured by company assets and, where possible, personal guarantees
• Subordination: Understand where your note sits relative to other creditors, subordinated positions face significantly higher loss rates
• Interest rates: Ensure rates reflect actual risk (typically 8-12% for seller notes), not just market convention

The key point isn’t that seller financing is inherently problematic, it’s that sellers should understand they’re taking real risk and structure accordingly rather than accepting terms reflexively.

Earnout Considerations and Risks

Recessions tend to increase earnout usage as buyers seek to bridge valuation gaps and protect against near-term uncertainty. However, earnouts carry significant seller risk that warrants careful attention.

Critical earnout risks include:

• Buyer operational control: The buyer controls business operations and has incentive to minimize earnout payout through aggressive cost management, reduced marketing investment, or other decisions that depress performance metrics
• Metric manipulation: EBITDA-based earnouts are particularly vulnerable because buyers control cost allocation decisions
• Dispute frequency: According to M&A dispute research, earnout disputes occur in approximately 30-40% of transactions with earnout components, often requiring arbitration or litigation to resolve
• Unsecured position: Earnout payments are typically unsecured, making sellers subordinated creditors
• Time value: Deferred payments should be discounted for both time value and collection risk

Practical guidance for earnout negotiation:

Industry practitioners commonly recommend limiting earnouts to 10-15% of total deal value to manage collection risk, though owners with limited bargaining power or declining businesses may need to accept larger earnout components to complete transactions. In those cases, structure becomes even more critical:

• Prefer revenue-based metrics over EBITDA, as revenue is harder to manipulate
• Include detailed calculation methodologies and audit rights
• Establish clear dispute resolution mechanisms with expedited arbitration
• Consider acceleration clauses if the business is sold during the earnout period
• Negotiate protection against changes in accounting practices or business operations that could artificially depress metrics

Sellers should model earnout scenarios conservatively. If your financial planning requires 90%+ earnout achievement to meet your goals, reconsider the deal structure.

Company-Specific Factors That Determine Recession Resilience

While macroeconomic conditions affect all transactions, the variance in outcomes between companies during recessions is substantial. Understanding the factors that drive this variance enables owners to honestly assess their company’s likely performance in downturn conditions.

Revenue Quality and Predictability

Companies with recurring revenue models, long-term contracts, or subscription-based business models tend to maintain valuations better during recessions than those dependent on transaction-based revenue. The predictability premium, already present in strong markets, appears to expand during uncertain periods as buyers place greater value on visibility into future performance.

This applies when contracts are legally enforceable, customers remain creditworthy, and historical churn rates are low. Recurring revenue provides less protection when customers face financial stress or when services are viewed as discretionary rather than essential. A “recurring” revenue stream from financially stressed customers in a discretionary category may offer less protection than project-based revenue from stable, essential-service clients.

Revenue quality factors that support recession resilience include:

Customer Concentration Risk

Customer concentration risk amplifies during recessions as buyers discount future revenue more heavily and consider potential loss of major customers. Research from M&A advisory firms including Lincoln International and Pepperdine’s Private Capital Markets Project consistently shows that concentrated customer bases correlate with valuation discounts, and this discount appears to widen during uncertain markets.

Owners of concentrated companies considering exits during uncertain periods should either prioritize customer diversification or expect to address concentration concerns through deal structure, potentially seller notes tied to customer retention or earnouts contingent on customer performance. Customer diversification timelines depend heavily on existing sales capabilities, market dynamics, and average sales cycles. Companies with concentrated customer bases should realistically expect 18-24 months for meaningful diversification, not the 6-12 months sometimes suggested.

Management Depth and Owner Dependence

Buyer concerns about owner dependence increase during recessions as they consider transition risk in challenging operating environments. Companies with strong management teams capable of operating independently, and potentially navigating difficult conditions, maintain valuations better than owner-dependent businesses.

Assessment framework:

• Can the business operate profitably for 6 months without owner involvement in daily operations?
• Are key customer relationships held by multiple team members rather than solely the owner?
• Do documented processes exist for critical business functions?
• Has the management team successfully navigated challenges without owner intervention?

If the answer to most of these questions is “no,” management development should be a priority, typically requiring 12-18 months of focused effort. However, management development requires genuine owner commitment to delegation, may involve temporary efficiency losses as new processes are established, and carries meaningful costs that owners should budget explicitly.

Balance Sheet Strength

Companies entering recessions with strong balance sheets, low debt, adequate working capital, cash reserves, are associated with valuation premiums during downturns, though factors such as industry resilience, business model quality, and management depth also contribute significantly to recession performance. Strong balance sheets may be both cause and effect of business quality.

Overleveraged companies or those dependent on credit facilities for operations face additional scrutiny during periods when their own financing access may be constrained.

Operational Flexibility

The ability to adjust cost structures in response to revenue changes, through variable cost models, flexible workforce arrangements, and scalable infrastructure, provides resilience that buyers value during uncertain periods.

The Real Cost of Exit Preparation

Before discussing preparation strategies, owners need an honest accounting of what preparation actually costs. Advice to “prepare your business for exit” often understates the true investment required.

Direct Costs

Indirect and Opportunity Costs

Preparation ROI Analysis

For preparation to create net value, the improvements must exceed total costs. Here’s an illustrative calculation:

Example scenario (your situation will differ):

Key assumptions this analysis requires:

• EBITDA growth rate achievable during preparation
• Multiple improvement from preparation activities
• Probability that market conditions don’t worsen during delay
• Business trajectory remains positive throughout preparation

If any of these assumptions prove wrong, preparation may not create net value. Owners should stress-test their specific scenarios rather than assuming preparation always pays off.

Decision Frameworks for Exit Timing During Uncertain Markets

Given the complexity of recession dynamics and the impossibility of precise market timing, how should owners approach exit decisions during uncertain economic conditions?

When Immediate Sale May Be Superior to Preparation

The preparation approach assumes owners have 18-24 month flexibility and believe preparation efforts will exceed opportunity costs. For owners in certain situations, accepting current market conditions may be superior:

When Waiting for Better Conditions May Be Superior

The Preparation Path: When It Makes Sense

Focused preparation makes sense when:

• Business has addressable weaknesses that materially affect buyer perception
• Owner has 18-24 months of flexibility and energy
• Preparation costs are modest relative to expected value improvement
• Business trajectory is stable or improving
• Market conditions are moderate rather than severely depressed

Preparation priorities in uncertain markets:

Failure Modes in Preparation Strategies

Preparation carries risks that owners should monitor:

Failure Mode 1: Business deteriorates during preparation

• Trigger: Competitive pressure, key customer loss, or market shifts during preparation period
• Probability: 20-25% depending on industry dynamics
• Mitigation: Set preparation deadlines with go/no-go decision points every 6 months; monitor leading business indicators; maintain deal readiness for opportunistic sale

Failure Mode 2: Market conditions worsen faster than preparation timeline

• Trigger: Severe recession, credit freeze, or industry disruption during preparation
• Probability: 15-20% in any given 18-24 month period
• Mitigation: Maintain optionality for accelerated sale; don’t over-optimize for perfect conditions; consider accepting solid offers even during preparation

Failure Mode 3: Preparation efforts don’t materially improve buyer perception

• Trigger: Fundamental business model issues that preparation cannot address
• Probability: 25-35% depending on starting position
• Mitigation: Get third-party validation of improvement efforts; focus on highest-impact activities; be honest about what can actually change

Personal Readiness Considerations

Economic cycles don’t respect personal timelines. The owner who delays an exit hoping for better conditions may find that years later, conditions haven’t improved, and they’re older, potentially more fatigued, and perhaps facing circumstances that limit flexibility.

Decision framework for personal timing:

For many owners, waiting for marginally better valuations costs more than you gain when factoring in personal timeline costs and uncertainty that conditions will improve, though this calculation varies based on business trajectory and personal circumstances.

Sector-Specific Analysis

Rather than responding to general recession fears, analyze how economic conditions specifically affect your sector and business model:

What Happens When Exits Don’t Work

Our analysis thus far has focused on companies that successfully transact. However, honest guidance requires acknowledging that not all companies find buyers during downturns, and understanding this risk should inform preparation decisions.

When Exits Stall

During significant recessions, a substantial percentage of would-be sellers don’t complete transactions. According to deal intermediaries surveyed by the M&A Source and IBBA, deal completion rates can decline 30-50% during severe downturns. Some outcomes include:

• Extended timeline: Deals that might close in 6-9 months during strong markets may require 18-24 months during downturns
• Significant price reduction: Sellers who initially reject downturn-level offers may eventually accept similar or lower terms after extended marketing
• Process abandonment: Some owners pull deals from market rather than accept available terms, planning to revisit later
• Distressed sales: Owners facing financial pressure may accept terms significantly below reasonable expectations

Risk Factors for Failed Exits

Businesses most likely to struggle finding buyers during recessions include:

Owners should honestly assess whether their business falls into high-risk categories and either address those factors (with realistic timelines and costs) or calibrate expectations accordingly.

Actionable Takeaways

Assess your recession resilience with specific benchmarks. Evaluate your company against concrete metrics:

Compare preparation against alternatives explicitly. Before committing to preparation:

• Model the immediate sale option with current market multiples
• Calculate opportunity costs of delayed liquidity
• Estimate probability that preparation materially improves outcomes
• Identify whether your business has addressable weaknesses or fundamental limitations
• Set decision points for abandoning preparation if business trajectory changes

Prepare for changed deal structures with clear risk limits. If you plan to transact during uncertain conditions:

• Limit seller financing to amounts you can afford to lose entirely
• If you must accept earnouts exceeding 15%, structure them defensively with revenue-based metrics
• Require security interests and personal guarantees for seller notes
• Build detailed metric definitions and dispute resolution into earnout agreements
• Model conservative earnout achievement scenarios (50% achievement, not 100%)

Target appropriate buyer categories. Different buyer types have different recession sensitivity:

Monitor leading indicators and set decision triggers. Rather than reacting to general recession news:

• Track your industry-specific leading indicators monthly
• Set specific thresholds that trigger preparation acceleration or process launch
• Maintain deal readiness even during preparation for opportunistic sales
• Review timing decisions quarterly against updated information

Conclusion

Recessions are inevitable features of economic cycles, not aberrations to be feared. Business owners who understand how downturns typically affect lower middle market transactions, and honestly assess how those dynamics apply to their specific situation, make more informed decisions than those responding to general anxiety. However, informed decisions don’t guarantee favorable outcomes when business fundamentals or market conditions work against you.

The evidence from multiple economic cycles suggests that well-prepared companies with strong fundamentals can often achieve acceptable exits during challenging markets, though typically with 15-30% valuation discounts and modified deal structures compared to strong market conditions. Strategic buyers continue acquiring, private equity continues deploying capital, and motivated individual buyers continue pursuing acquisitions. The market contracts but doesn’t close, though the composition of successful transactions shifts toward more resilient businesses, and companies with significant vulnerabilities may struggle to transact at all.

Your focus should be on factors within your control: building recurring revenue, diversifying customers, developing management capability, and maintaining operational flexibility. These characteristics drive value in any market environment. However, be realistic about what you can change within your timeline, some factors, like industry cyclicality, have real limits, and budget honestly for the costs of preparation.

Understanding recession dynamics enables better decision-making, but it cannot overcome weak business fundamentals, unfavorable market timing, or structural problems that preparation cannot address. If your business has significant vulnerabilities, cyclicality, concentration, owner dependence, debt, addressing those issues matters more than understanding market patterns, and you should evaluate honestly whether those issues are addressable within your timeline and resources.

Economic uncertainty is not a reason to delay exit planning, but it is a reason to be realistic about outcomes, explicit about risk tolerances, and honest about alternatives. The owners who navigate uncertain markets successfully combine informed preparation with honest assessment of their specific situation, clear personal priorities, and willingness to adapt when circumstances change. That combination of preparation, realism, and adaptability is what separates strategic decisions from reactive ones.