What You Need to Know About Family Businesses
Family businesses are critical to both the US and World economies. In fact, in the US alone, there are approximately 5.5 million family owned and controlled businesses.[1] While much of the world’s wealth is a byproduct of family-owned businesses, the fact is that most are not actually prepared to sell in a way that will profit the owners for their life’s work.
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Many owners of family businesses care deeply about the legacy that they built and want it to remain in their family or with someone that will continue it with the same mission, vision, and values on which it operates. This is often difficult as the owners lack an established succession plan or exit strategy.
Studies show that about one-third of family owners never even plan to retire. As a result, they have no succession or exit plan in place. In some cases, the business is forced to form a strategy by default when the business owner becomes burned out, disabled or worse, passes away. This is clearly not the best path when it comes to maximizing profits.
Pros and Cons of Conveying Your Business to Family Members
According to Businessweek.com, the average lifespan of a family-owned business is 24 years. About 40% of family-owned businesses are successfully passed down to a second-generation with only about 13% passed down to a third generation. [2] With the fourth generation and beyond, the survival rate is 3% or less. Regardless of whether a family business owner intends to convey their business to a third party or have it remain in the family, it is important to maintain confidentiality and have the proper documentation in place for a successful transition.
There are disadvantages that need to be considered if you plan to sell your business to a family member. One key disadvantage is that a family business owner will typically receive less value for their business than engaging the sale with an independent third party. Selling to an independent third party can often force a family business owner to also paradoxically agree to a lower value to negotiate the retention of jobs and incomes for the family members they wish to remain with the business after the sale. It is important to prepare the remaining family members that they will have to accept the fact that they now answer to new ownership and management with the business.
Handling Multiple Owners and or Decision Makers
If there are multiple owners and/or decision-makers in the family-owned business and the business is being sold to a third party, it is important to appoint one family member to represent the negotiations. Having multiple decision-makers at this critical step in the process of conveying the business to a third-party owner can lead to numerous issues and headaches for both the buyer and seller. Many times, multiple decision makers cause failure in the ability to transition the business to third-party ownership, as the parties involved have competing priorities with the sale of the business, which prevents satisfying everyone involved in the process. Keep in mind that all family members must be in consensus with the price, terms and sale of the business or it will never happen. This fact can be true even if the family members involved are just employees or active/passive investors in the business. Disagreements among family members often derail the possibility of a deal happening.
Obtaining Outside Assistance
To increase your probability of success with conveying a family-owned business to future generations or new independent ownership, having a third-party guide you through the process who is not emotionally involved like the various family members involved, can be critical in making the deal happen. That’s why a variety of professionals including business brokers, M&A advisors, lawyers, and accountants should be brought in to help.
This article highlights just a few of the myriad issues and processes involved in conveying your business to new ownership once you decide it is time to retire or move on to a new venture. If you are just beginning or actively considering transitioning your business to new ownership, please do not hesitate to reach out to us for advice and assistance.
[1] https://www.gvsu.edu/fobi/family-firm-facts-5.htm
[2] https://www.johnson.cornell.edu/smith-family-business-initiative-at-cornell/resources/family-business-facts/
Copyright: Business Brokerage Press, Inc.
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Family-Owned Businesses Do Have Choices
Family-owned businesses do have some options when it comes time to sell. Selling the entire business may not be the best choice when there are no other family members involved. Here are some choices to be considered:
Internal Transactions
- Hire a CEO – This approach is a management exit strategy in which the owner retires, lives off the company’s dividends and possibly sells the company many years later.
- Transition ownership within the family – Keeping the business in the family is a noble endeavor, but the parent seldom liquefies his investment in the short-term, and the son or daughter may run the company into the ground.
- Recapitalization – By recapitalizing the company by increasing the debt to as much as 70 percent of the capitalization, the owner(s) is/are able to liquefy most of their investment now with the intent to pay down the debt and sell the company later on.
- Employee Stock Ownership Plan (ESOP) – Many types of companies such as construction, engineering, and architectural are difficult to sell to a third party, because the employees are the major asset. ESOPs are a useful vehicle in this regard, but are usually sold in stages over a time period as long as ten years.
External Transactions
- Third party sale – The process could take six months to a year to complete. This method should produce a high valuation, sometimes all cash at closing and often the ability of the owner to walk away right after the closing.
- Complete sale over time – The owner can sell a minority interest now with the balance sold after maybe five years. Such an approach allows the owner to liquefy some of his investment now, continue to run the company, and hopefully receive a higher valuation for the company years later.
- Management buy-outs (MBOs) – Selling to the owners’ key employee(s) is an easy transaction and a way to reward them for years of hard work. Often the owner does not maximize the selling price, and usually the owner participates in the financing.
- Initial public offering (IPO) – In today’s marketplace, a company should have revenues of $100+ million to become a viable candidate. IPOs receive the highest valuation, but management must remain to run the company.
Source: “Buying & Selling Companies,” a presentation by Russ Robb, Editor, M&A Today
Copyright: Business Brokerage Press, Inc.
Read MoreBefore You Sell Your Family-Owned Business
There once was a family-owned bakery that had sales in the millions. The bakery sold bread to restaurants, supermarkets and some retail outlets. The founder gave each of his 5 children 20 percent ownership of the business. The kids really didn’t want to work in the business, so they turned the operation and management over to 2 members of the third generation. For some years the business had been operating on a break-even basis, and sales were not increasing.
The founder’s children decided that they wanted to sell the business since they were close to retirement age. A professional business intermediary was retained to do this. He contacted as many of the larger bakeries as possible, hoping to find a suitable acquirer, but there was very little interest. The intermediary continued his search, willing to do the hard work required to find a good buyer. He finally found a successful businessman who offered a price equal to 50 percent of sales – a generous offer.
The intermediary presented the offer to the five children – all equal partners. Little did he know that he had walked into the proverbial hornet’s nest. A huge family argument ensued, and finally the intermediary was asked to leave the room so that the siblings could decide what to do.
The offer was turned down flat. There was no counter-proposal or even any negotiation on price, terms or conditions. The offer was dead. The intermediary had worked on trying to find the right buyer, figured he had – all to no avail, six months wasted.
It turns out that the major obstacle was thrown up by those two members of the third generation who had been operating the business. They feared that they might lose their jobs even though the prospective buyer assured the sellers that he would retain them. Were they being unreasonable? The reality is that the operators were “family” – related in one way or another to the five owners, and blood is usually thicker than water.
Flash forward some 20 years. The bakery is still in business with very little growth and still operating on a breakeven basis. The five owners are now in their 70s, they have never received anything for their equity, and there is very little hope that they ever will.
The above is a true story. It shows how a family can own a business and not be prepared or in agreement when it comes time to sell it. Although the bakery is still in business, it is barely hanging on. The story is sad as well as true. The proposed deal could have satisfied all of the owners’ goals and made their retirement years a lot more comfortable.
Family-owned businesses make up a lot of the non-public companies in the U.S., and according to industry reports, many of them will be up for sale in the near future. In situations where the family owned business is owned by more than one person, it is crucial that a meeting be held with all of the family owners prior to electing to sell, unless a strong buy-sell agreement has already been agreed to. This agreement should establish, among other things, specific guidelines about what happens if one family member wants out of the business.
At this meeting, the company attorney and accountant should be in attendance along with a business intermediary. The reason to include the intermediary at this early stage is that he or she knows what the pitfalls are, what buyer concerns will be, and what should be done prior to going to market.
One of the major problems when there is more than one owner is communications. For example, one owner who is active in the business decides that he needs a new, expensive car and that the company should pay for it. This is the kind of issue a decision-forming meeting should bring to light and address. Strict guidelines should also be in writing concerning salaries, benefits, etc. When one family member wants to cash out or another one spends a lot of money furnishing their office – it is too late to have an agreement drawn up to cover these possible roadblocks. The time is now!