The Economy of 2005 and How It Affects Your Business

Here we go again.  It is the beginning of a new year.  It is time to consider where the U.S. and global economies are going, where will interest rates be, where will the value of the dollar stack up to foreign currencies.  Wow, that is a lot to contemplate but it must be done on an ongoing basis because of the effects it has for every business owner large and small.  The effects I am talking about relate to a business owners future and the decisions that must be made for the future of the business and the business owner.  The decisions a business owner must make to protect the value of his investment will ultimately rely on how he or she answers these questions. 

According to a survey of 56 economists, the U.S. economy will grow at approximately 3.6 percent during 2005.  The estimated outcome of GDP for 2004 was a little higher at 3.9 percent. This would be considered modest but healthy growth at a reasonable pace.  Of course, this assumption is based on stabilizing energy prices, little or no inflation and little rise in the short-term interest rates. Energy prices, primarily the price of oil, are certainly risks to these assumptions.  Conflicts in the Middle East, labor disputes in Nigeria, and the current disputes in Russia with its largest oil company are all factors that could upset the apple cart in terms of corporate profitability and real growth.  The falling dollar raises the price of imported goods thus causing inflationary pressures on our economy.  The survey however calls for a modest 2.5 percent increase in consumer prices for 2005.  This would be much slower than the 3.5 percent increase during 2004.  The Federal Reserve began raising interest rates in June of 2004.  The central bank increased rates a record five times and brought short-term rates up to 2.25 percent.  These increases represent a reversal of three consecutive years of interest rate decreases.  Although, current short-term interest rates are at multi year lows, the Federal Reserve is expected to take rates up to somewhere between 3 percent and 4 percent during 2005.  All of this information in my opinion suggests that the U.S. economy will have a decent year with healthy growth at a subdued pace.

The end of 2004 saw the mega merger deals begin to bloom.  December was the busiest month for mergers and acquisitions since August of 2000.  With corporate balance sheets flush with cash and economic forecasts of 3.6 percent growth, merger and acquisitions may be the only way to grow revenues and cash flows in 2005.  Venture capital firms raised more than $11 billion of capital in 2004 for investment in start-up entities and smaller capitalization companies.  It would appear that merger and acquisitions has just begun a new cycle.  Small business owners of middle size companies ($5 million - $25 million in value) could have many opportunities to cash out or simply merge and grow with a larger company.  We continue to see strong buyer side demand from hedge funds and private equity partnerships for mature profitable companies.  Additionally, more small capitalization companies are looking to consolidate their interests in the pursuit of growth.  U.S. companies are beginning to look very cheap to international based companies primarily due to the weakening dollar.  It is expected that the dollar will remain weak with regard to foreign currencies throughout most of 2005.  The weakness in the dollar has created an opportunity for international companies to pursue a growth strategy by buying up profitable U.S. companies.              

As a business owner, it is important to understand how your company fits in to the complex global economy.  It is equally important to continue updating your business and succession plans accordingly.  A business owner needs to make the right bets during any year to increase top line growth and cash flow.  Ultimately, good management and planning will make a business more valuable thus increasing stockholder net worth.  A business becomes more valuable when others realize there is value and, the time is right to invest capital.  The time may be right in 2005, as many buyer side firms will be looking to spend down the cash on their balance sheets as their own stockholders continually pressure them for growth. 

This article was written by Jeffrey J. Presogna, CPA CVA, and a Vercor partner. Mr. Presogna (Jeff@vercoradvisor.com) consults on the purchase and sale of mid-size private companies.