It seems that bubbles are everywhere. First it was the dotcom bubble in the late 1990s. Then it was the housing bubble that led to the Great Recession. Now we hear of bubbles in student loans, government debt and Bitcoin. Is it possible that the federal government is also causing a bubble in small company valuations? This question occurred to us when a very capable broker recently explained that he expects to get 1.5x sales for a metal fabrication company with less than $5 million in revenue and significant exposure to the retail sector.
What’s Going On?
There are various theories on why small company valuations are higher than their historical norms. According to some people, a slowly growing economy is causing relatively large strategic buyers to acquire even the smallest companies. The theory is that, because valuation multiples for these companies are so much higher than those of their competitors in the lower middle market, absent other growth opportunities, they are willing to buy small companies and outbid individual and financial buyers in the process.
Others claim that a rising tide is lifting all boats and that higher valuations for large companies are having a sympathetic effect on all company valuations. As a result, even individual and financial buyers are raising their bids for small companies. Still another theory is that the market is simply becoming more efficient and the increase in multiples simply reflects a movement toward intrinsic value.
But what if the real reason is that the SBA’s loan programs are so generous that they are artificially inflating small company valuations? As buyers, we love the SBA’s programs and use them whenever we can. The extra leverage they provide, as well as their manageable interest rates and amortization schedules, make it easier to stretch on valuation. But when, for instance, a company’s idiosyncrasies or the dynamics of the sale process preclude us from using an SBA program, we are frequently unable to meet the seller’s expectations. In these cases, we wonder whether our equity return expectations are too high or whether the SBA really is inflating small company valuations.
Regardless of whether the SBA has caused a bubble, its loan programs are a key reason why many small business owners are able to sell their companies, retire comfortably and ensure the ongoing job security of their employees. In many situations, especially when a company is not able to attract the interest of strategic buyers, the outcome for sellers will be much improved when they can accommodate a buyer’s occasionally cumbersome use of a government loan program to help finance the acquisition.
The more that sellers appreciate the impact that the availability of debt, regardless of its source, has on a buyer’s valuation, the more willing they may be to work with potential buyers to support their fundraising processes, and ultimately the higher the price their companies may fetch. During the debt raising process, we encourage all business owners to view buyers less as counterparties and more as partners working to maximize the amount of total capital available for their transactions.
If you are aware of business owners who would like to sell their companies, please consider introducing them to Bootstrap Capital. We are keenly in tune with the issues business leaders face when they decide to sell their companies, as well as many other nuances of transacting in the lower middle market. We work with a number of lenders who offer several different types of financing and endeavor to utilize the capital that best matches both the company and the business owner’s goals. Bootstrap Capital is a patient counterparty and can be a constructive partner in helping sellers through the sale process.