What's on the Mind of the Private Company Owner?

Thanks to the Private Equity Professional Digest for this snapshot of Pepperdine University’s newly released Private Capital Markets Study. The study provides insight into the entrepreneurial mind regarding risk, return and the current economic climate.

What’s on the Mind of the Private Company Owner?

February 26, 2010 – A new study by Pepperdine University shows that private company owners can generally be described as gut-feel, risk taking operators with short term payback expectations. Knowing these tendencies may come in handy at your next sit down with the owners and management team of a potential acquisition.

A large number of private business owners would take a business risk (91%) vs. maintaining the status quo (9%) and, at the same time, half (49%) said they rely on “gut feel” to make investment decisions according to the study. The study also shows that most private business owners expect at least a 20% return for investments within 1.5 to 3 years. Private business owners said if they were to invest in a company identical to their own, they expect a 20% return for a 10-year investment.

“Shrewdness, confidence and risk-taking are qualities that define a private business owner,” said the study’s author, Dr. John Paglia, an associate professor of finance at Pepperdine University’s Graziadio School of Business and Management. “However, private business owners may be unrealistic in gauging investments and risks as well as sources of funding or return on investment. Generally, there may be an unhealthy expectation that the next big break is right around the corner and should take big risks to capitalize.”

These findings were part of the Pepperdine Private Capital Markets Study, an investigation of the major private capital markets that examines the current state and outlook for the private capital industry. The private business owner data is based on interviews with 304 business owners and is part of a larger study based on interviews with more than 700 professionals in the private capital industry. The Pepperdine Private Capital Markets Study provides insights into four other private market segments in addition to venture capital: bank, asset-backed, mezzanine and private equity lenders.

Other Findings:

(1) Despite being generally optimistic about prospects for growth, many businesses are struggling – 30% indicate the probability of failure increased over the past six months, 46% report decreased access to capital, 34% report declines in the number of employees, 38% report declines in the size of industry, 50% report increases in competitive pressures, 36% report a decline in confidence of economic growth, 33% report declines in revenues, 22% report declines in pricing.

(2) When evaluating investments, businesses report using payback analysis (54.0%), market analysis (51.5%), “gut feel” (48.5%), internal rate of return (41.3%), and discounted cash flow analysis (34.9%). Larger companies (>$1M in revenues) rely more on payback (62%) and internal rate of return (48%). Smaller companies rely more on market analysis (55%), and payback (47%).

(3) A general investment in the business yields a 20% return expectation. They expect a 10% return from purchasing a new phone system, 20% for a new computer system, 25% for expanding a current market niche or entering a new one, and 30% for hiring a salesperson and acquiring a competitor.

(4) Businesses report payback thresholds of approximately 1.5 years for hiring a sales person, 2 years for a new computer or phone system, 2.5 years for expanding a current market niche, 2.8 for entering a new niche, and 3.2 for acquiring a competitor.

(5) Businesses report the most important factors when borrowing include interest rates, collateral requirements, loan size, and customer service. Companies are less concerned with location of lender, sophistication of bank, and length of loan term.

(6) Businesses expect a 20% annual return for a passive, minority equity 10-year investment in an identical business. They place a premium on time as they’d expect 12% for a one-year investment and 15% for a five-year. Businesses prefer to use external equity to acquire a competitor while siding with personal equity for general expansion of business.

(7) Most businesses would take a business risk to achieve financial independence as opposed to maintaining a current lifestyle. For increased expected returns, nearly 91% are willing to take a business risk vs. 9% who prefer the status quo.

(8) When faced with multiple investment opportunities, all with identical expected returns, nearly 75% of businesses are willing to take a significant business risk on a chance to earn greater returns despite lower odds.

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The survey also includes input from bankers, private equity investors and venture capital groups. To download the 124 page report, go to http://bschool.pepperdine.edu/research/pcmsurvey/.