Illiquid investments and trapped wealth

March 13, 2019

As a business owner, you need to decide whether you have a business (something that may be sold later) or a job. A job provides short term financial security, and if you are organised, you will set some of this aside for the future.

If you are a genuine business owner, treat your business like an investment, rather than a personal bank account. Refer to my previous post for more Private Business as an investment.

A private business is an illiquid asset. You can’t convert it into cash, at least not overnight and without a lot of preparation. The value (wealth) is trapped in your business.

To give you an example, a recent scan of small businesses for sale indicated:

  • more than 2,900 small businesses were on the market (at least publicly)^
  • this represents less than 1.5% of all registered businesses (based on 2017 ABS statistics referred to in my previous post Business Valuation “Tsunami”
  • the average list price was $430,000, with 50% listed for $250,000 or less
  • 47% of the business are in the “Food & Drink” industry, such as cafes and restaurants
  • the total value (based on all prices) of the businesses for sale was $1.2 billion, being less than 1.5% of the value of all businesses (as per my previous post)*.

It will be great to see how many of these small businesses actually sell. Until then, estimates suggest that only 10% to 20% of businesses that are listed will sell (source: Forbes). There are a bunch of reasons for this, but I won’t go into that now.

Let’s go with 15% of listed businesses end up selling.

So, of the 2,900 businesses for sale, only 435 will sell. This means the remaining 2,465 have wealth trapped in their businesses (more than $1 billion in total) and may never see their illiquid investment converted into cash.

Don’t get me wrong, there are lots of terrific small businesses. We all rely on them for our morning coffee, sandwich for lunch, haircut, car service, book-keeping and so on. In fact, small businesses are more likely to provide a consistent level of personal service than larger companies which fail to consistently achieve this basic expectation of customers (cue: Financial Services / Aged Care Royal Commissions).

Delving deeper, more than 85% of these businesses employ four staff or less (60% self-employed). Many self-employed or small employee business owners will not sell their business, even if the business is financially successful.

How much of your wealth is trapped in your business?

 

 ^Based on internet based listings in last seven days, excluding new franchises and multiple listings of the same business.

*In a previous post I estimated the value of all businesses in Australia totalled $850 billion (This is very basic given the value of more than 2,000 ASX listed companies exceeds this).