Updated: Oct 13, 2018
Recurring media coverage and Pepperdine University’s ongoing Private Capital Markets project have increasingly brought the anticipated “baby boomer effect” on M&A into the business community’s consciousness. For the last two years the Private Capital Markets project has listed the number one reason for small- and middle-market business sales to be baby boomer retirement. Inc. magazine reports that the size of this effect is “65 percent to 75 percent of the small companies in the U.S. – some 10 million – will likely hang up a “for sale” sign over the next five to 10 years.”
What has received only occasional coverage, however, is an unfortunate statistic listed deeper in the Private Capital Markets project report—almost 40% of attempted business transfers fail. And the largest reported reason for a transaction not succeeding is a valuation gap between sellers and potential buyers. And of those that do close, many only do so because of seller price concessions or other undesirable transaction terms. In real world terms, this means that thousands of business owners who have worked hard and taken risks throughout their careers to build their businesses may not be able to realize the retirement and next generation legacy for which they have planned. Entire lifetime dreams may deteriorate when the business owner retires.
Over the next decade baby boomer business owners will be competing with an increasing number of their peers for buyers of their businesses thereby exacerbating the problem. “While it has historically been a seller’s market, we’re on the cusp of shifting into a buyer’s market”
What causes the valuation gap? While this can sometimes be caused by unreasonable expectations by one or both parties, the gap often arises logically from the company specific risk premium attributed to a seller’s business by a buyer. Characteristics of a business such as customer concentrations, disorganized financials, lack of documented processes, and—all too often—overreliance on the owner of the business, all make a potential buyer nervous about how sustainable the business will be after it changes hands. The only way a buyer can become comfortable is to lower the offering price to the point at which even with post-closing uncertainty, a return on investment can be achieved.
Properly preparing a business for sale can take multiple years, and the business owners who sell for premiums are those who have methodically created an entity that can live beyond them. Any business owner who is contemplating a sale within the next five years should begin preparing now. The business owner should clean financials, document processes, create and follow a strategic plan built around the company’s clearly articulated competitive advantage, and work to make himself obsolete. Even independent of any increase in cash flow, these steps will reduce a buyer’s perceived risk, thereby increasing valuation. And here’s an extra perk: companies that take these actions usually realize increased cash flow, as well. A double bonus: increased cash flows and a higher multiple on top of those increased cash flows.
Retirement is looking better already.