It’s tough to build a business in a down market, and to grow past certain business size ‘walls,’
How can business owners best operate in a down market?
Business owners looking to sell their business need to pay attention to the markets. That seems to be a pretty obvious thing and maybe even a trite statement.
We’re working with one business which is down 20 percent, who had an offer on the table in December, and would have closed then based on trailing 12 months and forgetting the 20 percent down.
She thinks the business internally is just worth more than that and she’s decided to hold out.
The fact is her trailing 12 months is going to continue to trail down. She’s in an industry where it’s affected by the economy; a good part of it is discretionary. She probably turned down the highest price she’s going to see on that business at least in the next several years.
Regarding operating a business, it’s easy to say plan ahead, that’s obviously the advice in a nutshell, but what does that mean? It means conservative financing of the business.
The bankruptcy numbers are disproportionately high now due to those businesses that use leverage to buy a business or manage to borrow more money in the course of operating the business.
When the margins squeeze, when the business revenue cuts down 30 or 40 percent, all of a sudden you can’t service the debt.
So it’s conservative business standards, and for most business owners we don’t have to tell them that. Small and middle market business owners don’t like that trip to the bank. They only go there when they have to. They’re guarding against the excessive capitalization of the business, excessive debt in the business.
The debt in most businesses exceeds the equity. There’s nothing wrong with that, that’s normal, but it depends on how much it exceeds the equity.
Let me translate that to the equity in the private business. In small and middle market private business, family and friends was the traditional thing.
In the last up cycle, private equity groups became a dominant player. I’m pretty confident that private equity groups this year own about 48 percent of the capitalization of the mid market. And by mid market, I’m not talking about the public mid market, that’s a sliver of companies.
I’ve studied businesses with revenue greater than $5 million but less than $500 million. If you were to capitalize that whole market, private equity groups rather than individuals will now own about 48 percent of that market. It’s a very different market than it was six or eight years ago.
Speaking of market walls or business growth walls. Does this to mean that there are barriers to companies reaching certain sizes.
In the mid market, businesses with revenue $5 million to $500 million, there are only about 350,000 of those in this country, 350,000 out of 27 million businesses.
Let me rephrase that in another way. There are 27 million businesses in the United States currently. Only 350,000 of those have revenue more than $5 million. That’s a huge wall, getting over the $5 million dollar mark.
So 97 percent of the businesses in the United States have less than $5 million in revenue. I think that’s prima facie evidence that walls to growth exist.
I also break the middle market into lower middle, mid middle and upper middle. If I broke it, for example, at $10 million rather than $5 million, 125,000 of those businesses would be all that remains.
So we look at revenue greater than $10 million, 125,000 businesses in this country. That wall between lower middle and mid middle is very steep. And, again, the wall from mid middle up to the upper, and the upper middle market, there’s only about 12,000 companies.
Some of us overcome these walls but the odds are very much against us.
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