Professor Bentley (not his real name) was one of the most revered yet feared professors at Harvard Business School. Every time he entered the classroom, you knew you were in the presence of genius. But with one question, he could make you look or feel like the village dunce.
I didn’t learn the principle of supply and demand at Harvard, I knew that a long time before I got there. However, in the rigorous case study methodology used there, Professor Bentley helped us appreciate how the simple principle of supply and demand could explain the growth and decline of most industries.
Professor Bentley has since passed away, may he rest in peace. But I think about him when I consider the present supply-demand disconnect when it comes to the buying and selling of privately owned businesses. In theory, supply follows demand and when demand exceeds supply, prices go up; then, demand subsides at which point the market reaches equilibrium (pardon the over-simplification, I’m trying to make a larger point).
I live at the intersection of supply and demand for privately held businesses. I can tell you with complete certainty, there is enormous demand to buy privately owned businesses. I hear every day, literally every day, from either a private equity firm, individual, or business wanting to buy a privately owned business. The motivation of each buyer is different, but the intention to create value through acquisition is identical.
There is, simply said, a lot of demand.
What has me flummoxed is supply (businesses for sale) has not risen to meet this demand. I even think Professor Bentley would be confused. I talk all day every day with owners of privately held businesses (i.e., supply), yet I don’t see them rushing to meet the demand. It’s as though the laws of economics are being defied. So with this limited supply, you’d think prices would increase, right? Well, wrong. While demand is indeed outpacing supply, supply is not increasing its pricing to create market equilibrium.
Bottom line, supply stays relatively static even while demand intensifies.
Oh sure, there are businesses bought and sold every day, and those of us who live in this marketplace are doing just fine, thank you. But I don’t see a material break in the paradox of demand outpacing supply. This gives rise to the question, why aren’t more businesses (supply) being sold (meeting demand)?
I know of no studies that answer this question, but I can provide an antidotally-based perspective given many years living in this market environment. First, the supply that exists does not perfectly match that for which the demand is looking. The privately owned businesses trying to be sold in many cases just don’t have the return-on-investment potential the demand demands. Second, there are external constraints on how much demand can drive pricing, such as restrictive bank lending standards and alternative channels of investment (public markets, etc.). You have to remember, money is a commodity in search of a return. If sufficient returns are not available from investing in privately owned businesses, that money will flow to other investment categories that offer a better risk/reward tradeoff.
There is great anticipation for the time when the supply of baby boomer-owned businesses come on the market. Indeed, some business broker/M&A types call it a “coming tsunami” in the hope of fearing business owners to get ahead of the curve and sell before the “tsunami” hits. In theory, they are saying supply will soon outpace demand. However, as I see it, though the demand will not go away anytime soon, supply will continue to be constrained. If you own a business that meets the demand parameters, this is a great time to sell. But if you’re one of 8 million baby boomer business owners holding on, don’t expect to get bailed out by the aggressive demand. You see, demand will continue to be rational and responsible. Professor Bentley would be surprised; the laws of supply and demand just don’t seem to apply in the market for privately owned businesses.
JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee.
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