An estimated $3 trillion dollars will be “left on the table” by small business owners due to failure to plan their business exits

blog_mouse_pc_400_clr_2729My previous blog posting, Reconstructing Avery’s $10.4 Trillion in Business Transfers, details the assumptions and calculations supporting my estimate that the total business valuation for small businesses (which I define as 49 or less employees) is just short of $4 trillion dollars ($3.775 trillion based on my calculations).  That valuation number assumes all small business owners do whatever is necessary to prepare to have a saleable business.  We all know that is not the case.  In fact, an ROCG study of 502 respondents with revenues between $1 million and $100 million found that only 9% had a formal, written transition/succession plan.  For the businesses that interest me – 49 employees or less, I’d guess the existence of formal exit plans may be under 5%, possibly closer to 1%.

It is generally accepted that only 20-25% of small businesses ever sell.  Some would argue the true number is not even that high.  The number one reason small business are not saleable is the business owner’s failure to plan for the sale of their business.  Most owners don’t even realize the necessity to plan for their business exit.  Many think selling a business is like selling a home, but they couldn’t be more wrong.  They have no idea of the number of obstacles they might face.  In fact, in future posts, I will detail and address 66 obstacles I’ve identified that owners must be prepared to address and overcome or minimize.

So, here’s the really bad news that can be deduced from all these statistics.  Assuming only 20-25% of small businesses ever sell and the value of all small businesses (49 or less employees) is approximately $4 trillion dollars, one can deduce that 75-80% of all business owners are likely to leave a total of approximately $3 trillion dollars on the table through failure to plan for their business exits.

I am very interested in your feedback and comments.  Do you agree with the assumptions? What can we do about it?  How can we reach small business owners with this distressing information?

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Reconstructing Avery’s $10.4 Trillion in Business Transfers

blog_mouse_pc_400_clr_2729In an extensively quoted 2006 report titled: “The Ten Trillion Dollar Question: A Philanthropic Gameplan”, Robert Avery, an economist and demographer of Cornell University, allegedly estimated that $10.4 trillion of net worth will be transferred by the year 2040 by baby boomers. He is also quoted as indicating the majority of boomer wealth is held in 12 million privately owned businesses. I say “allegedly” because I have tried in vain to find the report by Avery online. However, that $10.4 trillion aspect of the report is quoted extensively by numerous sources online.

I was hoping to see the details supporting Avery’s estimate. Without finding it, I decided to see if I could reconstruct the details.

My interest lies in educating business owners with up to 49 employees (my definition of small businesses) of the need to plan for the sale of their business. I want to determine the estimated total business value of small businesses in the U.S., assuming all business owners prepare to make their businesses saleable.

So, here’s how I’ve gone about it. First, I obtained the “Private Sector Firms by Employment Size of Firm – 2010” provided by the SBA (http://www.sba.gov/advocacy/849/12162). According to those records, there are almost 4.8 million privately owned businesses with 1-49 employees and only 221,660 businesses with 50 or more employees. In addition, there are about 21.7 million non-employer establishments (think: sole proprietorship with no employees). (http://www.sba.gov/sites/default/files/SBE_2011_2.pdf)

Here’s a table summarizing the data by number of employees.

Private Sector Firms by Employment Size of Firm – 2010

Employment Size of Firm

Number of Firms

Percentage of Total

Cumulative Percentage

Non-employer firms   (think sole proprietorships with no employees)          21,700,000

Not included

NA

1-4

2,810,228

56.0%

56.0%

5-9

993,757

19.8%

75.8%

10-19

615,441

12.3%

88.1%

20-49

375,647

7.5%

95.6%

50-99

117,857

2.3%

97.9%

100-249

66,196

1.3%

99.3%

250-499

19,117

0.4%

99.6%

500-999

8,802

0.2%

99.8%

1,000-2,499

5,397

0.1%

99.9%

2,500-4,999

1,943

0.0%

100.0%

5,000-9,999

1,032

0.0%

100.0%

10,000+

1,316

0.0%

100.0%

Total

5,016,733

100.0%

100.0%

Source: U.S. Small Business Administration, Office of Advocacy, from data provided by the U.S. Census Bureau, Business Dynamics Statistics (www.census.gov/ces/dataproducts/bds/). Non-employer firms source: (http://www.sba.gov/sites/default/files/SBE_2011_2.pdf)

Note that 95.6% of all private sector firms with employees have 49 or fewer employees. If non-employer firms are included in that computation, the percentage becomes 99.2%.

To continue reconstructing Avery’s $10 trillion business value number, I used the above SBA data, then estimated the value of businesses. (My calculation chart is displayed below.) For those under 49 employees, I used the mid-point of the range of number of employees and multiplied that number using a valuation average of $75,000 per employee, then multiplied by the number of firms. The valuation estimate of $75,000/employee was based on the businesses I’ve sold over the years. My business sales ranged from $100,000 to $5,000,000 and averaged about $1,100,000 (excluding real estate sold with businesses). That $75,000 may seem high to some, but I was very selective in the businesses I chose to represent and thus my findings may reflect a slightly higher number than the experience of other brokers. Throughout this article, I am assuming business owners have maximized the salability of their businesses. Under that assumption, I believe the $75,000 business value per employee is reasonable.

For those firms with over 49 employees, I assumed large firms are generally more efficient than small firms, so for those I used an estimated valuation of $100,000 per employee. I also researched that estimate and did find some support. Again I used the mid-point of the range of the number of employees and multiplied by the number of firms.

For the 21.7 million non-employer firms (think sole proprietorships), I’ve used an estimated value of $50,000 per business. That may be a little high, but as previously stated, I’m assuming that small businesses can be sold if the owner properly addresses the obstacles they face by planning for the sale of their businesses.

Before going further, I realize businesses should be valued based on their earnings – seller’s discretionary earnings for smaller businesses and EBITDA for larger businesses. There is no bigger supporter of the need to base valuation on earnings than me. I despise rules of thumb and generalizations (especially overstatement of value) when it comes to business valuations. But, I am taking on a challenging task here, and have to use “back of the envelope” estimates for the data I’m trying to develop.

My goal is to estimate the “potential” business value of all small firms, assuming their owners properly plan for their business exits. In fact, only a small percentage of businesses are saleable because owners fail to even realize the need to plan for a transfer. My estimate of $75,000/employee business valuation may be optimistic, but it assumes businesses are saleable because that’s the number I’m trying to reach.

So, here’s my chart of estimated business valuations for all privately owned U.S. businesses.

Calculating Estimated Business Values for All Private Sector Firms

Number of Firms

Employment Size of Firm

Mid-point of Employee    Range

Estimated Business Value per Employee

Calculated Total Business Value for All Firms in Employee Range

21,700,000

Non-employer firms (think sole proprietorships with no   employees)

NA

$50,000

(see assumptions)

$1.085 trillion

2,810,228

1-4

2.5

$75,000

$527 billion

993,757

5-9

7

$75,000

$522 billion

615,441

10-19

14.5

$75,000

$669 billion

375,647

20-49

34.5

$75,000

$972 billion

TOTAL CALCULATED BUSINESS VALUE – for all firms with under 49 employees, including non-employer firms (based on stated assumptions)

$3.775 trillion

117,857

50-99

74.5

$100,000

$878 billion

66,196

100-249

174.5

$100,000

$1.155 trillion

19,117

250-499

374.5

$100,000

$716 billion

8,802

500-999

749.5

$100,000

$660 billion

5,397

1,000-2,499

1749.5

$100,000

$944 billion

1,943

2,500-4,999

3749.5

$100,000

$729 billion

1,032

5,000-9,999

7499.5

$100,000

$774 billion

1,316

10,000+

10,000

$100,000

$1.316 trillion

TOTAL CALCULATED BUSINESS VALUE – for all firms with 50+ employees (based on stated assumptions)

$7.172 trillion

TOTAL CALCULATED  BUSINESS VALUE – for all private sector firms (based on stated assumptions)   $10.947 trillion

WOW! When I started with this exercise, I was unsure what results my assumptions might yield. Avery estimated that $10.4 trillion of net worth will be transferred by the year 2040 by baby boomers. My calculated estimate shows a total business value of $10.9 trillion for all private sector businesses. So, I’m feeling pretty good about my results.

Most importantly, I found the number I was searching for. The chart above shows the estimated value of small businesses (with 0-49 employees, including non-employer firms) is $3.775 trillion. The implications of that number will be discussed in my next blog posting.

I am very interested in your feedback and comments on the above analysis. What are your thoughts?

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