American hero & astronaut, Buzz Aldrin, famously said, “Timing has always been a key element in my life. I have been blessed to have been in the right place at the right time.”
I have been a business broker since 1994. I have experienced market conditions where buyer demand to purchase privately held companies and family owned businesses exceeded the supply of quality businesses creating a seller’s market. I have also experienced market conditions where buyer demand to acquire companies was weak and sellers were happy to find a party interested in buying their businesses.
Unique market dynamics in 2018 appear to have created an equilibrium in the middle market of the mergers & acquisitions marketplace for privately held companies where sellers with proper motivation to sell their profitable companies are in balance with appropriately motivated buyers interested in acquiring businesses at a “fair market” value in “win-win” transactions.
The unique market conditions have several components. The first component creating the market conditions is the age of the Baby Boomer generation. The Baby Boomer generation starts with people born in 1946 and ends with people born in 1964. The population of this generation in the United States is approximately 76 million or 28% of America. This population is presently participating on both the sell and buy side of transactions.
On the sell side of transactions, many Baby Boomer entrepreneurs have reached the age where they have accumulated the necessary wealth to retire and desire to sell their profitable businesses to travel, play golf, and spend time with family & friends without constraints. The perfect time to sell is when you want to sell, but do not need to sell. The transition of an owner out of a business can take 3 – 24 months depending on the industry, location, and seller’s role in the operation & management of the company. It is prudent for an entrepreneur to start the sale process when they are in good health, have the time to smoothly transition ownership in the best interest of the business, and can negotiate with potential buyers to achieve a “fair market” value for their business in a “good faith” negotiation. Many Baby Boomers born between 1946 – 1953, ages 65 – 73, have reached this decision creating a supply of quality businesses to purchase for buyers.
Similarly, many Baby Boomers born between 1955 – 1964, ages 54 – 63, have reached the decision that for the last chapter of their professional lives they would like to be entrepreneurs. Many of these individuals have spent a majority of their professional lives working in corporate America. They have accumulated significant knowledge, experience, and capital and desire to leverage those assets to facilitate the ability to make executive decisions without oversight and generate returns off the labor contribution of employees rather than being asset someone else reaps profits from through employment. It is also common for corporate executives to desire to purchase businesses to reduce travel, gain more control of their time, and/or avoid being replaced by younger, less expensive individuals who have more current knowledge & skill sets. Individuals from these two ends of the Baby Boomer generation are often matched in “win-win’ transactions by professional intermediaries at IBA that at times can resemble the handing over the reigns of a company from an older to a younger sibling. One advantage of being from the same generation is that Baby Boomers often have an easy time developing rapport with each other and understanding the other side’s perspective based on sharing similar life experiences. It is always easy to do business with someone you like & respect.
Another market element that is presently creating good conditions for the purchase & sale of a business are the favorable interest rates available for business acquisition loans. It is rare for a business buyer to complete an acquisition with 100% of their own capital in the middle market. A common solution to facilitate obtaining the necessary money to acquire a company is to supplement personal funds with capital from a SBA (Small Business Administration) backed loan. If the business acquisition does not include real estate, this will be a 7A loan. The interest rates associated with this loan product have been at historical lows since the great recession. However, in recent months as the Federal Reserve has started to increase its benchmark rate the interest rates associated with SBA 7A loans have started to rise.
June 13, 2018 the Federal Reserve increased its benchmark rate from 1.75 to 2.00%. This was good macroeconomic policy for the United States. However, this interest rate increase resulted in an increase of the prime interest rate from 4.75 to 5.00%. The prime interest rate is a common foundation element for determining SBA loan interest rates. SBA 7A loans are commonly financed at 2.00 – 3.00% above the prime interest rate. SBA loans can have fixed or variable interest rates. The Federal Reserve indicates that multiple additional increases to its benchmark rate are on the horizon as it tries to manage the strong economic growth presently occurring in the United States economy and reestablish an important management tool for mitigating stress on the economy during the next economic downturn.
Increases in SBA 7A loan interest rates for business buyers can have a negative impact on values achieved for privately held companies and family owned businesses in transactions. The negative impact occurs because as interest rates rise two things occur for a business buyer. First, the amount of money they will take home from the business after debt service decreases. One of the primary motivations for buying a business is return on investment. The less money a buyer takes home the less valuable a business is to them as an acquisition. A drop in net income also impacts the business borrower’s ability to repay business acquisition loans.
Bank underwriting for all loans will establish a minimum debt service coverage percentage. Traditionally, we have seen 15 – 30% above anticipated cash flow after payment of a “fair market” salary to the business owner for their labor contribution to executive management of the business for 7A SBA loans. This calculation has a direct impact on the amount of money a bank will loan for a business acquisition loan. The less money a bank will loan, the less money a buyer will pay for a business. If all business buyers for a specific company have similar resources, experience, and motivation to acquire a business the increase in interest rates will ultimately have a negative impact on business values. Low interest rates for acquisition loan products result in higher prices for sellers and buyers being able to purchase larger companies. Conversely, higher interest rates do exactly the opposite. The present interest rates available for business acquisition loans are favorable. The consensus of the banking community is that they will not be getting lower during the remainder of the decade.
A window of opportunity exists in 2018 when a supply of mature, quality businesses can be matched in the marketplace with buyers with the necessary resources & experience to successfully run the businesses post acquisition. Market dynamics are destined to change in the future. If you are Baby Boomer entrepreneur that wishes to sell a business in 2018, we would welcome the opportunity to provide an overview of the services IBA offers its clients. We are confident that we can match your business with a buyer and achieve a sale value that may not be achievable in future years.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, and mergers & acquisitions community on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.