04 May The Effect of Entitlements on Business Brokerage, Private Equity and Investment Banking
Because much of what we do is focused around the middle market and our own skin, we often fail to miss larger broad market effects when and the impact they will yet have on the world. I like to consider myself bullish on the U.S. of A. long term, but when I read doomsday reports on entitlements from constant doomsdayers like ZeroHedge, it makes me a bit more reticent to jump on that bull and ride with vigor. There are positive things occurring as the boomers advance in years, but unfortunately, the negatives that are in our future stand blaring us in the face, the proverbial and unavoidable train wreck or the elephant in the room.
The upside is this: 10,000 baby boomers are expected to retire each day for the next 19 years. The downside: 10,000 baby boomers are retiring daily. On the positive side of the equation we see approximately 300K baby boomers making their exit from the workforce monthly. This astounding number of eventual retirees caries with it one of the largest transfers of wealth in the history of mankind. Many of these individuals own and manage successful middle market businesses with plenty of profits to go around. In other words, those who have prepared themselves for the coming shift in assets and wealth will prove extremely helpful at transitioning between the generations. However, there are so many other cogs in the scenario which need addressed it’s frightening.
Take for instance the fact that most boomers have less than $50,000 saved for their retirements. This means the majority of people will be highly dependent on Uncle Sam to fund their retirement. The difficult piece of this puzzle is the explosion of entitlement spending that is about to take place, something completely correlated with the mass exodus from the job market. Here are some additional alarming statistics put together by the Congressional Budget Office:
- Without entitlement reform federal spending will exceed 40% of the economy by 2050
- Deficit spending for entitlements, including Medicare and Medicaid began in 2010. It only gets worse as the backlog of retirees begins
- Medicare is currently the biggest vacuum for federal spending and its growing at an alarming rate
- Without intervention by 2045, tax revenues will be fully eclipsed by Medicare and Medicaid alone
- Entitle spending is expected to double by 2050
- Tax increases on the wealthy will not solve the issue
- Tax rates on all Americans will need to double in order to simply cover the expected costs of the debacle
What does this mean for the investment banking industry? My prediction is that the middle market multiples will be even more suppressed than we have seen them previously. Valuations of middle market companies will be much lower than their larger S&P traded counterparts due in part to customers’ willingness or ability to pay. Higher expected taxes reduces the excess cash on hand for small firms to reinvest and expand their business via acquisition. Sellers will be more likely to sell at discounts to ensure that at least they are able to get something out of their baby and have at least a semi-comfortable retirement. Deal terms could most likely favor strategic buyers even more, especially if they have money. Individual buyers will probably also gain a little more negotiating power than they have had in the past as well.
We’ll most likely also see a shift in the way businesses are perceived as well, which could further impact valuations and most likely in a negative way. With the uncertainties looming large in the not-to-distant future, the options seem bleak at least for some. We can be confident and highly bullish of the fact that there are still businesses that need to be sold and the coming years will see a huge shift in the volume and need for such services.