For several years there has been a great deal of anticipation surrounding the demographic shift and its effect on the market for SMEs (small and medium enterprises). What impact does the shift in demographics have on the sale of your business? If you have a genuinely strong business, the answer is: not much.
When it comes to selling small and medium enterprises (SMEs), the main considerations for owners tend to be the financial strength of their company and the economic environment.
One thing that is rarely considered, but has generated plenty of discussion in recent years, is demographics.
But wait — what do demographics have to do with anything?
Some will argue that it’s a straightforward supply and demand issue. But is it that simple?
We are now entering the period of time that researchers have predicted to be the most impacted by aging SME owner demographics. This occurs when the effects of Covid-19 virus panic and its fallout are creating massive headaches for owners who are intending to sell their businesses. Despite the hype, the demographic shift really isn’t going to be that important for most business owners.
THE RETIREMENT GLUT
The Canadian marketplace is now experiencing a massive transfer of ownership as a wave of “baby-boomer” business owners approach retirement.
CIBC World Markets called this forthcoming transfer of businesses the largest in Canadian history. In 2012, they wrote that $3.7 trillion in business assets were going to change hands over the next decade as 550,000 retiring owners exit their companies.
As we approach the tail end of this timeline, economic turmoil has played a hand in accelerating the timeline to retirement for some Canadian SME owners, and for others delaying the planned exit from their companies.
One thing that hasn’t changed is the linear nature of time: Business owners are getting older regardless of the performance of their business over the course of the last year. With increased age comes a greater sense of urgency to transition or exit from the business even if results did not match previous forecasts.
Extrapolating forward, a significant group of business owners that have remained with their businesses are approaching the top end of the retirement age group.
SMEs that will experience a change of ownership over the next decade account for 3.5 million workers and nearly a quarter of Canada’s entire GDP. This trend is continuing to this day, and into the future as the boomer generation seeks to exit their businesses in the most lucrative way possible.
SUPPLY AND DEMAND
Businesses will hit the market more than ever due to this demographic issue. With post-virus recovery on the horizon, business owners that saw their valuations take a hit in 2020 are now able to return to a point where a sale makes sense. Confidence among buyers is strong as well.
However, less than a third of all family-owned businesses will transfer to the next generation. Some others will be acquired by strategically- or financially-motivated corporate buyers or private equity groups. Many PE firms and corporate finance firms focusing on SMEs have found a great deal of success in recent years due to the tidal wave of business sales. Our indicators tell us that these groups are still finding value as a result in the demographic shift of business owners and the subsequent massive transition of ownership.
So the argument about how the retirement glut might be affecting your business sale goes something like this:
On the one hand, the glut is resulting in an increased supply of businesses for sale. Won’t your widget factory command a relatively lower price if there are 10 other widget factories hitting the market at the same time?
As Deloitte stated in one of their reports:
With a glut of baby boomer- owned SMEs imminently available, there is an untapped and growing opportunity for Canadian private equity firms to realize significant value at the low end of the micro- cap market. Canada is arriving at a natural inflection point where baby boomer small business owners will need to consider selling. This will sharply increase the supply of available businesses – a market reality that simply did not exist five or ten years ago.
On the other hand, the massive amounts of capital required to buy all of these companies is depleted as time goes by, and costs of capital will increase if interest rates rise following this extended period of all-time lows. Therefore, won’t there be fewer capable buyers to pay the big premiums for your business?
Conventional wisdom says you should hurry to “beat the rush” and test the market posthaste in order to get the highest price.
THE FALLACY OF THE SME RETIREMENT GLUT ARGUMENT
The supply and demand situation is a little more complicated than the above argument makes it out to be.
First, remember this: Every business will eventually sell or die.
With that in mind, it’s important to recognize that a lot of the businesses included in the above statistics will simply die, not sell.
The statistics include a lot of one-person businesses that are more or less someone’s job. This is in fact a majority of the registered businesses in Canada. These are often not sellable.
Meanwhile, many other businesses might be bigger, but are so owner-dependent that when the owner goes, the business can’t last. For middle market businesses with some real “sellability,” the fact that all these sorts of owners are actively looking to retire is largely irrelevant.
The numbers also include numerous businesses that are insufficiently profitable and therefore not worth buying as a business (though they might have a few good assets someone will want, like a nice piece of equipment or a building).
It also includes businesses that rely on soon-to-be obsolete technologies or business models. These companies will not sell — they will perish, because the changing dynamics of the marketplace will not accommodate them.
We speak with business owners all the time who have faced declining sales for years because they are behind the curve due to changing technology.
These earlier studies also could not predict the destructive government response to the 2020 pandemic, which pulled the switch on businesses. Many businesses following traditional models that might have otherwise made it to a natural transition of some kind have simply ceased to exist due to the global pandemic.
A further consideration is also very important: businesses are not commodities like gold or coffee beans. Just because the supply of “businesses for sale” is going up does not mean that the price of a particular business will necessarily be bid down. Businesses cannot be considered homogenous.
Imagine a machine shop for sale. It is profitable and has a specialized product line focusing on huge components. Now imagine another machine shop hitting the market as well, it too is profitable, but it instead focuses on mass production of tiny bits. The fact that the second machine shop is for sale is mostly irrelevant to the price the first machine shop can sell for.
You might think a financial buyer might bid prices down if they have lots of companies they can consider. Many private equity groups tend to look at companies more on a stand-alone basis in terms of its ability to generate cash flow. But companies with different financial profiles are not really part of the same “supply,” even if they are in the same industry selling similar stuff to similar customers. A company steadily earning 30% EBITDA with a strong recurring revenue profile is a much different “good” than a company steadily earning 10% EBITDA with more erratic sales. The 30%-margin company’s valuation won’t be bid down just because the generic “supply” of businesses is higher.
CONCLUSION
In reality, if you have a business that is worth buying, the retirement glut doesn’t mean that much, regardless of the rising supply of businesses for sale. It will still be worth buying even if a dozen “similar” businesses are put up for sale.
Instead of focusing on the demographics issue, business owners should focus on making their company worth buying on its own terms.
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Even if you are not planning to sell your business any time soon, this information is valuable for ALL business owners, large and small.
