A decade ago, Richard Jackim and Peter Christman wrote a book entitled The $10 Trillion Opportunity. The second edition had the subtitle of “Designing Exit Strategies for Middle Market Business Owners.”
While the book did provide a guide for financial advisers working with middle market business owners, I don’t recall that it provided a basis for the bold claim of a $10 trillion opportunity to work with business owners. That’s not a complaint. They recognized that with an aging business owner population, the opportunity had to be enormous, and $10 trillion sounded enormous.
Since reading their book many years ago, I have often thought about how that ownership transition opportunity might be quantified. I looked at a variety of business statistics sources over the years and never found anything I thought was helpful.
The Basic Census Bureau Data
Recently, I decided to look again at statistics published by the United States Census Bureau. I looked at a data series titled:
Statistics about Business Size (including Small Business) from the U.S. Census Bureau
At the above link, I found a table titled “Receipt Size of Firms, 2007.” The table provided a listing of companies in various sales (or receipts) categories. Being an analyst, I wondered if I could turn that one-dimensional table into an analysis that could yield insights into the coming multi-trillion transfer of private business wealth.
I took the basic information and made a few assumptions about margins on sales, and therefore, earnings, and generic valuation multiples for companies of various sizes. My purpose is not, of course to value anything other than the magnitude of private business ownership transitions that are coming down the proverbial pike.
The basic information looked as follows for companies with up to $100 million in sales.
We can observe a few things from this portion of a larger table:
- There are more than 580 thousand companies with revenues between $2.5 million, which is small as I took this analysis, and $20 million. Combined sales totaled $3.6 trillion in 2007, the latest year the statistics appear to be available.
- When we move to the revenue category of $20 million to $50 million, the number of companies consistently declines by category as revenues increase. There are some 61 thousand companies in this category, with combined sales of $1.9 trillion.
- The category of $50 million to $75 million indicates an interesting increase in the number of companies to 14 thousand. There are less than 7 thousand companies in the $75 to $100 million sales category. The 22 thousand companies in the overall $50 million to $100 million category have combined sales of $1.4 trillion.
- Finally, the grand totals at the bottom indicate a total of 662 thousand companies with sales between $2.5 and $100 million. They have total combined revenue of almost $7 trillion.
The Census Bureau combines all companies with more than $100 million in revenues into a single category. This category has 20.6 thousand companies representing some $20 trillion in sales. I’ll save analysis of this category for later. For now, let’s deal with the companies with sales from $2.5 million to $100 million.
“Valuing” the Transition Opportunity for Companies with Less Than $100 Million in Sales
There is no information about profitability for these companies. I have made a simplifying assumption that the smallest companies have an average pre-tax profit margin of 6.0%. As the companies increase in size, the profit margin assumption rises to a high of 7.5% for the companies approaching $100 million in revenues.
I recognize that this is a very simplifying range of profitability assumptions, but it makes sense to me after looking at many hundreds of companies in these size ranges. In any event, the assumption is clear.
Now that we have assumed earnings for all these companies, we can “value” them in aggregate with a range of pre-tax earnings multiples. I’ve assumed a range of multiples of estimated pre-tax income of 6.0x for the smallest companies up to 9.0x pre-tax income for the largest businesses. The following table provides the results from this analysis.
With a combined estimated pre-tax earnings of $450.3 billion on sales of $6.9 trillion, the under $100 million sales companies have an estimated equity value of $3.2 trillion. To reach a $10 trillion opportunity, we will have to investigate companies with sales of more than $100 million, which we can’t do at this point with information available. I’ll work on that later.
Testing the “Valuations”
Let’s try to put these “valuations” into perspective. If we assume that the companies above are in aggregate financed 80% with equity and 20% with debt, then, the combined market value of total capital (there is no way to make an assumption about aggregate cash) is $4.0 trillion (Equity Value of $3.2 trillion divided by 80%). Assuming an interest rate of 6% on the combined $800 million of debt ($4.0 trillion MVTC times 20%), interest expense is about $48 billion.
Earnings Before Interest and Taxes (EBIT) is therefore $498 billion (pre-tax income of $450 billion plus $48 billion of interest). The implied multiple of EBIT is therefore 8.0x ($4.0 trillion MVTC divided by $498 billion of EBIT).
Using the EBITDA Depreciation Factor from a couple of posts ago, we can estimate the implied multiple of EBITDA. Recall that the average EBITDA Depreciation Factors for both the (non-financials) S&P 500 Index and almost 600 industry sub-categories from Risk Management Associates 2014 are 1.28x. This means that, on average, depreciation is about 28% of EBIT across many companies and many industries.
Given the implied EBIT multiple of 8.0x, we can derive the implied overall EBITDA multiple to be 6.24x (8.0x EBIT multiple divided by average EBITDA Depreciation Factor of 1.28).
I calculated the implied multiples of MVTC/Sales under the above assumptions. They range from a low of $0.45 to a high of $0.84, and the average multiple is $0.57.
I admit that this entire analysis is fabricated, but hopefully, the fabrication is reasonable. The implied valuation multiples do seem reasonable.
The $4+ Trillion Opportunity
There are 662 thousand companies with sales under $100 million (and over $2.5 million). All of them will face ownership and/or management transition issues over the next decade or so. I say this for three primary reasons:
- If national statistics hold, about two thirds of the 662 thousand businesses are owned by baby boomers. Their transition issues are apparent.
- Based on my experience and no actual study, I estimate the half-life of business ownership to be on the order of 10-15 years. During any 10 to 15 year period, at least half of any group of companies is likely to sell out or otherwise transition ownership.
- The rest of the companies will also experience ownership and management issues where they may need assistance. There will be enough talk and news about transition issues that the owners of any remaining companies will be sensitized to the issue.
If my “valuation” numbers are even reasonably in the right ballpark, there will be a $3-plus trillion wave of ownership transitions in companies under $100 million in sales over the next 10 to 15 years. The analysis is made based on 2007 sales figures. If sales have grown over the last eight year at, say even 3%, then my $3.2 trillion “valuation” for companies with less than $100 million in sales could have risen to more than $4.0 trillion.
Business owners are becoming increasingly aware of the inevitably of ownership and management transitions. They are aging, and they are talking with a growing cadre of consultants of a number of stripes who work on one aspect or another of the ownership transition spectrum.
There are a number of transition-oriented, exit planning organizations, whose members include financial planners, accountants, attorneys, and consultants of numerous stripes. These organizations include:
- Business Enterprise Institute – Exit Planning for Advisers
- Exit Planning Institute
- Exit Planning Exchange
- Pinnacle Equity Solutions
- Purposeful Planning Institute
Of course, the 662 thousand companies are also clients of accounting firms, law firms and other professional service firms who also provide assistance with transition planning and who may not be affiliated with any exit planning organization.
The opportunity for advisers is real.
But don’t forget that the opportunity for successful ownership and management transitions is of critical importance for every business owner.
Maybe this post will be thought provoking for both owners and advisers.
How About $10 Trillion?
There isn’t enough detail in the Census Bureau data for companies over $100 million in sales to do even a rudimentary analysis. There is no breakout of sales by size category once sales exceed $100 million. However, there are 20,605 companies in the Census Bureau data with combined sales of $20.3 trillion in 2007.
It is not clear how public companies are treated in the Census Bureau studies, but it would appear that the over $100 million category would include a portion or all of the public markets.
The bottom line is that I’ll try to “value” the over $100 million private marketplace if and when meaningful data become available. However, it is just a guess, but if we add private company America with sales over $100 million to the list, the ownership transition opportunity just might be $10 trillion, and possibly more.
After talking about such large numbers, it seems strange to talk about such a small number as $35. But that’s the price of my Ownership Transition Bundle ($35), consisting of my two most recent books, Unlocking Private Company Wealth($25) and Buy-Sell Agreements for Closely Held and Family Business Owners ($25). It is a bargain relative to the single price of the two books.
So, be well until next time!