Is it time to buy a business?
SOURCE: BDC Monthly Economic Letter
Over the next few years, there will be a significant increase in the number of small businesses for sale.
Because so many entrepreneurs are heading for retirement. Small business owners are generally older than the workforce. Indeed, nearly 60% of Canada’s small business owners are 50 years old or older. This demographic reality means that four in 10 small business owners are planning to exit their businesses in the next five years, according to a new BDC study.
What does the retirement of so many entrepreneurs mean for the economy?
There are over one million small and medium-sized businesses in Canada, accounting for approximately 40% of gross domestic product. With 40% of entrepreneurs planning to exit their businesses over the coming few years, roughly $300 billion worth of business value will change hands via transfers of family businesses to the next generation, sales or liquidation.
Over the next many years, we should anticipate an increase in entrepreneurship dynamism. Since 2001, business creation has been relatively stable, with the creation of an additional 11,000 active firms each year. However as entrepreneurs retire and sell their businesses, more new firms will be created, stimulating the economy.
An opportunity to scale up!
With an increase in businesses for sale over the next few years, valuations are likely to be driven down. This presents an opportunity for entrepreneurs to scale up their businesses by making acquisitions. That’s good news for the Canadian economy which is marked by a large number of very small businesses. Companies that can scale up through acquisitions will typically be better positioned in their market, enjoy greater economies of scale and be more competitive both at home and abroad.
A possible drag on investment
On the other hand, entrepreneurs planning to exit their business may be less likely to pursue growth or take risks. This may put an additional damper on already lacklustre business investment levels in Canada. Once newly amalgamated businesses are able to capture new markets, investments should increase.
Knowledge will not necessarily be lost
Often, when the older generation leaves the workforce, there is fear that knowledge will be lost. However, about a quarter of entrepreneurs planning to exit their business will transition their firm to the next generation. Another 50% of entrepreneurs will sell their firms, but many of these sales will be to the management team.
In both cases, knowledge about the business will be preserved. Even in cases where owners sell to outsider buyers, former owners often stay involved, ensuring some level of knowledge transfer.
Where are the opportunities?
Buyers and sellers both have an interest in what kinds of companies have the best prospects and therefore will attract top prices.
According to BDC’s research, the most sought-after firms are those which have a good track record of at least three years of healthy cash flow and low operating costs. In recent years, firms with the fastest growing revenues have been in construction, manufacturing, professional and technical services, and transportation and warehousing.
Furthermore, export-oriented companies outshine their domestically-focused counterparts in terms of revenue and profit growth, with nearly twice as many exporters reporting 25% or more annual growth in profits than non-exporters, based on BDC’s study Exporting: A key driver of SME growth and profits.
Owners of exporting firms tend to be older and have more experience (10+ years) and thus may be looking to exit in the coming few years.
To ensure full value at the time of sale, owners need to maximize their firm’s cash flow as this variable is critical in estimating enterprise value. If you are planning to sell your business in the near future, check out The Coming Wave of Business Transitions in Canada: Are Entrepreneurs Ready to Exit Their Company? for tips on how to maximize your firm’s value.