Business Makes Money
They related the price of an asset to the income or benefit it provides. An economist may call this its utility. This is how it is possible to guess whether it’s priced too high or too low. In extreme situations, we may characterise the price as a bubble. There have been famous examples of these bubbles peppered throughout our history.
You may be familiar with the Dot-com bubble that burst in March 2000. Often they are clear only in hindsight and it takes a cool head to get out of the market while it is still going up at a dizzying rate. The elation from the huge capital gains to be made by participating in the rise of a bubble is second only to the despair that follows its collapse.
Another example of a bubble occurred a few years later and bought in the Global Financial Crisis. This was in the residential property market in the United States. The Big Short is a movie that shows how a faulty banking system allowed the use of non-recourse loans to enable speculation in the property market by even the least sophisticated investors.
Only the most cool-headed of investors could see this bubble was happening. They made fortunes that were beyond the dreams of avarice. It was driven by leverage that was available to investors, enabling them to purchase properties with very little deposit and scant proof of serviceability.
Money making from the housing market
Although leverage is a theme that is commented on in the Australian media, this article does not want to call the housing market in Australia as being in a bubble. Too many people have made that call over the last few decades and will forever regret not having entered it and taking advantage of price rises. Part of the difficulty of identifying a bubble is because of its rarity. It’s always hard to believe one is happening.
The reason for this article is to propose that there is at least one market in Australia that is not in a bubble. That is the small to medium enterprise market. Also known as the SME market. The price of an SME business has been between one and four multiples of its earnings, more often in the lower half of this range for year after year, decade after decade. Compare this money making ability with other assets.
Of course, there is a range of businesses making money that will attract higher prices than this. They use a unique set of rules and often benefit from government protection or regulation. In the long run, even these businesses are brittle and can suffer sudden price changes. Taxi licences anyone?
These businesses are illiquid and the most important role that a business broker plays is to treat them in such a way as to make them less illiquid.
- We accomplish this in several ways.
- By standardising their pricing.
- Producing Information Memorandums to describe them accurately. By marketing them.
- Having the connections in place to provide finance and legal advice.
- Putting a negotiated deal into a contractual form and determining the conditions of sale.
- A big role is also absorbing heat in a negotiation so that all parties stay in the tent. Basically, it’s to show that a business makes money.
Increasing interest rates in Australia and around the world have affected the price of passive assets. Of course, what really happened was that interest rates reverted to normal after the medicine that the world had to take to survive the global financial crisis forced them so close to zero that it doesn’t matter.
This near-free cost of money and the ready availability of credit to purchase passive assets like property and shares had the effect of increasing the demand for these assets and driving up their prices.
Can you imagine someone considering purchasing a business? It would require active participation and soak up a lot of attention. Further, since banks are good at lending to purchase passive assets but are loath to lend money to someone who wants to purchase an SME, they would force you to pay for the business out of cash reserves.
Hurdle rates
In financial terms, this imposes a high hurdle rate on the decision to purchase a business. Visit “Investopedia” for more information about “hurdle rates“.
For most of the last decade and especially the years through the pandemic, using your money as a deposit towards purchasing a residential property gave you a very high return on equity with no effort required after the purchase.
The same money used towards the purchase of a business would yield a smaller asset since finance is nowhere near as forthcoming as it is to purchase a property.
In addition, is the requirement to be actively involved in the business’s operation. Whereas in the purchase of a property you could count on a high return on equity to make it worthwhile, the difficulty of getting finance for a business means you have to rely on the return on investment, which is much lower. Add to this the indignity of having to work for your money.
Throughout the course of the latter part of 2022 and to date, this equation has not held. The increasing cost of leverage has caused stagnation and even falls in the median price of property around most parts of the country. Now the opportunity to own a business looks like a direction worth considering. It’s purpose is making money. That’s its job.
That’s its job
The job of a business is very simple. It is to make money. If you put the effort in and run it properly, it will do this for you from the moment you purchase it. It also has protection from the risk that you will pay over the money for it since we have not subjected them to the price increases relative to their income that the passive assets have had.
You can make your money back in about 2 years most times and then still have the asset to sell when you decide the right time has arrived for you to do that.
The financial markets are finally approaching some sort of normality. The pricing of risk is possible again now that interest rates are off the floor.
Business Makes Money – Google
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