Part 1 – Stream of retiring business owners holds threat of mass liquidations and untold job losses. But there is a solution.
A largely unrecognized, systemic problem is hurtling toward our still fragile economy — the baby boomers who built it are now leaving it. They are putting their companies up for sale, resulting in an unprecedented glut of businesses on the market. There is growing evidence that the majority will go unsold, resulting in shutdown and liquidation of those businesses, with the commensurate loss of jobs and economic value to their communities.
The numbers tell the story
Around 75 million baby boomers are on the verge of retirement. For the next fifteen years or so, an average of 10,000 people a day will reach age 65.
This is significant because about 60% of all small businesses in the U.S. are owned by boomers and it’s estimated that two-thirds of those businesses will be put up for sale in the next five years. That’s many hundreds of thousands of companies and several trillion dollars in value. Surveys reveal that beginning with the last quarter of 2012, and increasing ever since, the desired retirement of the owner is the primary reason for selling a business. And since businesses with fewer than 20 employees make more than 50% of all U.S. jobs, that trend could spell huge trouble for communities everywhere.
Where are the buyers?
For businesses up to around $1 million in sales, the average buyer is typically an individual who wishes to be an owner-operator. Institutional buyers, like corporations and investment funds, are normally only interested in buying business with more than $50 million in sales. So even in “normal” times, buyers are thin on the ground for many small businesses. But flood the market with small businesses and you quickly overwhelm the ability of an already inadequate pool of buyers to absorb them.
As a result, a large number of those businesses will simply be shutdown (current estimates run as high as 80%), with the loss in value to the owner, the employees and the community.
Who has a vested interest?
The scale of the problem demands a systemic solution, as individual buyers can’t be materialized out of thin air. So the premise we start from is that an institutional solution it is called for. But who? And why would they want to? How?
We begin by asking who has a vested interest in seeing those companies remain alive and contributing to local economies. The employees might become the buyer (and sometimes do), but they usually lack resources, both money and skills.
What about the children or grandchildren of the retiring owner? Historically, only about 30% of second generation family members have attempted to take over, and less than half of that in the third generation. Those numbers have gone down in recent times and does not account for the high . Thus family members are not a viable solution.
Another group with a vested interest is the community itself. The closure of every business has a financial impact on the community. The most obvious is the loss of the tax dollars that local governments need to provide services. However, the loss of payroll dollars is even more problematic.
The multiplier effect says that each time a dollar is spent locally it winds up being re-spent anywhere from 2 to 15 times. If I spend part of my paycheck at a local restaurant, the owner might use that money to pay a local accounting firm, which uses it to pay a local graphics company for promotional materials, which uses it to pay a local IT services firm, which uses it to pay employees, who continue to recirculate the money.
Thus every new dollar injected into a local economy multiplies into many dollars and generates tax revenue. The loss of a dollar has the opposite effect. That’s why local economic development efforts focus on job creation and retention.
Therefore the constituency with the greatest vested interest in solving this problem is the community where the business is located. And as a group, they have the resources and skills to achieve that goal. They just need a track to run on and guidance on how to accomplish it.
The biggest obstacle they face is succession, i.e., the handover from the business owner to a successor manager. Many small business are owner-dependent and may not be salvageable, but for those that are, how can the community take over the business and keep it productive?
A structure that works
For the community to acquire the business, some legal vehicle is needed to serve as a joint ownership mechanism. For-profit corporations are a logical vehicle in that they are capable of owning other businesses, and the corporation in turn can be jointly owned by multiple owners. Those owners can be individuals, other businesses, non-profits and government entities, i.e. just about anybody in the community. This provides us with the optimum ways of aggregating financial resources to buy a number of local small businesses.
Berkshire Hathaway is a public company, which means its shareholders can buy and sell their shares on the open stock market just about anytime they want. That type of investment is generally referred to as “”, i.e. it can be readily converted into cash whenever the owner wants to sell.
Normally ownership in small businesses means the exact opposite. Owners can have a very difficult time selling their interest, generally characterized as illiquid. The illiquid nature of small businesses makes it a problematic investment.
If only a community holding company could be designed to buy small, privately held businesses, yet provide shareholders with the liquidity of a public company!
The BDC solution
It just so happens there actually is a type of corporation specifically designed to be a public holding company for small private businesses. It’s called a Business Development Company.
BDCs were created by Congress in 1980, following encouragement from the venture capital industry to establish a means that would allow the general public and not just the wealthy to own a piece of VC funds that invest in small businesses. BDCs were designed to be public companies that can be owned by anybody, with a mandate to invest in, own or provide loans to small businesses. Thus they are a hybrid of a public holding company, a venture capital company and a commercial lender.
In addition, the concept of a community owned entity that provides a broad benefit to the community and all stakeholders is an idea that fits a more progressive vision of the purpose of corporations in our society. The article Capitalism 2.0: 7 Reasons to Believe the Transition has Begun explores this new approach to corporations and its relevance in using BDCs to support local small businesses.
Part 2: Retiring business owners lack buyers for their companies — how can a BDC address this problem?
In Part 1, we discussed how the flood of retiring baby boomer entrepreneurs is creating a glut of businesses for sale, overwhelming the ability of the market to absorb them. The resulting shutdowns can have dire consequences for local communities and economies. We introduced a special kind of public holding company called a BDC as a way for communities to purchase those companies and retain their jobs and services.
Because a BDC is designed to be a public company, it can raise an IPO, conduct follow on public offerings, as well as raise money privately. Therefore a community centric BDC should be able to raise the funds necessary for an acquisition campaign to buy local businesses for sale.
In addition, if the BDC is a public company (they can be private), it can use its own shares as some or all of the currency needed to purchase those business. That is, a BDC can use cash, stock or both to purchase a company. In fact, properly structured, the portion of the purchase done with the BDC’s stock can result in a tax deferment until the seller later sells the BDC shares it received. For retirees, this can spread out their tax liability for selling their companies, and potentially realize a greater gain than an all-cash purchase, if the shares of the BDC grow in value while they hold them.
That deal structure can apply to other businesses for sale. They are being impacted by the glut created by the retirees as well, and thus they face the same increased difficulty in finding a buyer, much like any homeowner would in a down market, regardless of their reason for wanting to sell their home. Thus a community based BDC could buy those other businesses as well and retain them as an asset of the community.
A community BDC can entertain other kinds of small business investments as well. Companies needing capital to grow and create new jobs are a viable constituency that such a BDC could support. Likewise startups, the intended target of the original BDC legislation, could receive funding from a community centric BDC. Such efforts could be married with local economic development efforts, like a community small business incubator, to provide the critical funding such startups need to get off the ground.
And because a BDC is also allowed to do commercial lending, that opens up additional ways that a community BDC can support its local business. Unlike a bank that very rarely takes an equity position in the companies it lends to, a BDC is free to structure any kind of a deal, capital or credit. For example, that might include a multi-party transaction with a community bank that usually needs collateral to back its loans, the collateral possibly being provided by the BDC, and/or the BDC can take a subordinated position to the bank in a joint loan. There are many options.
In addition to providing financial support, a BDC has a legal obligation to “make available management support” to its portfolio companies. Most small businesses that are not part of a national chain have virtually no external support system or resources. It often is a sink or swim environment. Clearly, having an acquired or funded business go under is not in the best interest of the BDC and its stakeholders.
The BDC, therefore, provides a spectrum of support services to its portfolio companies including, at minimum, mentoring, monitoring and advising. In addition, it can provide shared services like accounting, legal, payroll and insurance that help to reduce costs to the individual companies. General and cross-marketing is another area where a BDC can provide support to its portfolio companies.
Benefits to sellers, investors and the community
A community BDC is that rare thing that works for everyone. Some of the key benefits to the various participants are outlined below.
Benefits to Sellers
- Sale is generally faster and easier than finding, being evaluated by, and negotiating with a private buyer, if one can even be found.
- By taking advantage of a stock swap option, sellers could realize a substantially larger gain than with a conventional sale and less money has to be raised by the community to acquire those companies.
- BDCs have the flexibility to structure the sale on the seller’s terms.
- The process can be entirely transparent to all.
- The community BDC’s goal is NOT to pay the lowest price but to keep the business local and operating.
Benefits to Investors
- Small investors can support their local economies while building wealth for themselves.
- Investment is in a public company, therefore shares are liquid (freely tradable).
- Risk is spread through ownership in multiple businesses.
- Investor confidence is enhanced through transparency and proximity.
- Companies have access to business support services that can improve operations and profitability.
- Investors receive a double bottom line benefit – financial gains and a healthier local economy.
Benefits to Communities
- Retain viable businesses that provide the community with useful goods and services.
- Job retention and creation.
- Maintenance and enhancement of tax revenue.
- Recirculation of money as a result of local ownership boosts all local businesses.
- Thriving business districts attract more business.
- Helps ensure a healthy mix of businesses to counter market-specific cycles.
- If the community wants its BDC-owned businesses to be more socially and environmentally responsible, it can elect to have the BDC and all its portfolio companies adopt policies and procedures.
Thus a community centric BDC can be a very flexible financial institution that can not only be used to address the critical problem of businesses possibly being shut down and jobs lost, but can help to expand local business and create new jobs, and even to make them model corporate citizens in sustainablility.
How would a community establish its own BDC?
There are two ways a BDC can be set up and managed:
- Internally managed: BDCs can legally be administered internally just like any other public company.
- Externally managed: They may be managed externally in a fashion similar to the way a venture fund is managed by a separate venture capital management company.
In either case, there are at least three ways that a community could set up its own BDC to address the needs of its local small businesses, whether to serve as a vehicle to acquire the companies being sold, or to provide investment and/or credit to others. They could:
- Start from scratch and form their own BDC corporation, get it approved with the SEC as a public company, arrange for an IPO and conduct follow on public and private offerings, and use the funds so raised to support their local small businesses. This is the hardest path and the least efficient. There are a lot of legal complexities involved, even though the process itself is fairly straightforward.
- Join forces with other communities that likewise have an interest in establishing their own BDC in a “fund of funds” approach. Each community would set up a subsidiary under this joint BDC to serve as its own virtual BDC for that community. (My company, Commonwealth Group, has coined the term Virtual BDC™ or VBDC™ to describe these entities.) Each of the communities can raise their own funds to be primarily directed to their local effort. However, all investors get stock in what would wind up being a much larger public company than might be achieved for a single community BDC. That would increase the likelihood of interest in the public market to buy shares in that group BDC, and likewise spread the risk over many more companies. This approach achieves an economy of scale in that only one parent BDC company needs to be set up, go through all the legal steps to become a public company and list its shares on the stock market. As with the first option, the process is straightforward once understood.
- Lastly, a community can work with a BDC that has already been set up to provide a home for multiple VBDCs. My company, Commonwealth Group LLC, has established a company for that purpose. Called Commonwealth Capital, it has been formed to provide a common umbrella for others wishing to establish their own BDC effort but who don’t want to invest the time, expense and effort involved in going it alone. Commonwealth Capital was formed as a California and fully embraces sustainability and triple bottom line for itself, its VBDCs and all their portfolio companies. Commonwealth Group serves as the external management firm (both fund management and administrative management) for Commonwealth Capital.
For options 1 and 2, Commonwealth Group can consult with others to establish their own, or partner with local organizers who would like to establish their own BDC.
In option 3, Commonwealth Group already has a BDC and has the structure and expertise in place to help others form VBDCs under it. Commonwealth Group is seeking to establish VBDCs with partners interested in addressing the problem of small business owner retirement, as well as investors and business owners interested in taking advantage of our solution.
At this time we are particularly interested in sellers who have professional management in place or sellers who can be replaced with a manager(s) to run the business. For those satisfying that succession requirement, we are prioritizing acquisitions with sellers who are willing to take stock in Commonwealth Capital as a public company BDC.
Michael Sauvante is Executive Director of Commonwealth Group LLC, the only firm specializing in the use of BDCs for small business investments. Commonwealth Group has formed its own California “fund of funds” BDC that can partner with others wishing to form their own BDC, including impact investors. To learn how you might use BDCs for your particular objectives, go to . You can also join the only LinkedIn group dedicated to BDCs .