Thomas Carlyle infamously dubbed economics “the dismal science.” The dubious title came in response to Thomas Malthus' 18th-century theory that human population would rapidly outpace food production and we would all starve to death. But if we're all still here, why does the tag stick? One could argue that it does because economics at its core is all about making decisions (some of them tough ones), and people by nature do not like making difficult decisions.
The decision to sell a family business ranks among the most difficult. After a lifetime of commitment, owners wrestle with a range of emotions and questions. Among these is how to achieve liquidity and diversify their family's wealth while still considering the best interests of their business and its employees, customers and vendors. Reluctance to face these tough questions often leads to procrastination and inertia among entrepreneurs who have forged their success through foresight and action.
Interestingly enough, it would seem that life sometimes has its own way of making decisions for us. The decisions that we obsess over can turn out to be minor in the long run, and others that we didn't even realize we were making at the time can turn out to be the most important ones.
The economic principle that we all natively understand is opportunity cost. Every time we decide to do something, we rule out all of the other possibilities. Often, people will become paralyzed by the notion that they have “missed the boat.” This is not a new idea; we see it in American popular culture in the character of George Bailey in It's a Wonderful Life. George is lamenting his decision to run the family business while his childhood friend Sam Wainwright makes a -fortune investing in a new invention called “plastics.”
Buyer interest remains high
When considering a decision to sell the family business, many owners, not unlike George Bailey, are currently lamenting that they may have missed out on a hot M&A cycle that had been on an upswing since 2002. Despite the turmoil among mega-deals on Wall Street, however, underlying conditions in the middle market (transactions less than $500 million in enterprise value) and lower-middle market (transactions less than $100 million in enterprise value) remain favorable in historical terms. When compared against longer-term averages, buyers are still paying historically attractive prices for high-quality companies. While the average purchase multiple for middle-market deals has dipped from its summer 2007 high, it remains relatively strong.
Even in today's environment there is a high degree of interest in acquiring or investing in family businesses by both corporate buyers and financial investors. Corporations are being pressured by shareholders to demonstrate growth, either organically or through acquisitions. As a result, many are actively seeking horizontal or vertical integration opportunities.
Generally speaking, it is relatively easy for corporate buyers to take on middle-market transactions without needing to “bet the farm” on larger acquisitions. For the last several years, nearly 60% of our firm's client companies have been sold to corporate buyers. Even in today's challenging credit environment, this trend -continues.
A sale to financial investors, also known as private equity groups, also remains a viable option for family businesses. While contraction in today's lending markets has had an impact on private equity transactions, this group of acquirers remains interested in high-quality companies that fit with their strategy and expertise.
Many quality private equity groups have a specific focus on closely held or family businesses, and while the most common transaction involves change of control, some private equity groups have developed specialized transaction structures to address the unique needs or desires of family sellers. One such structure, for example, involves a phased buyout whereby the family owners initially sell less than 50% of the company's equity and maintain some degree of control over the business. This option enables the founding family members to liquidate a substantial portion of their investment while also staying involved in the day-to-day operations and participating in the future growth of the business.
Navigating the process
Once the decision is made to sell their company, most family business owners hire investment bankers (in addition to their normal cadre of M&A attorneys, tax specialists and estate planners) to help them navigate the demands and intricacies of a sale process. An outside adviser's perspective is helpful because selling a family business can be such an emotional event for the sellers.
A common mistake among entrepreneurs is to believe they can correctly identify who will be the ultimate buyer of their business and therefore can directly negotiate a deal. Their belief is usually based on prior conversations or unsolicited expressions of interest. In 90% of our transactions involving this type of “pre-emptive” interest, running a competitive process has resulted in a sale to a different buyer on more attractive terms than the initially identified party. The reasoning is simple: Without the threat of credible competition, buyers will rarely serve up their best proposal and, as a result, the seller's negotiating leverage is diminished.
An adviser can help the business owner stay focused on running the daily operations of the business during the sale process. The greatest detractor of value occurs when the owner takes his or her “eye off the ball” and the company misses budget in the midst of critical negotiations with the potential buyer.
>Careful approach needed
Many surveys indicate that close to 6 million family businesses are estimated to be quickly approaching a crossroads. How will their upcoming decisions affect their family and their personal well-being? What will become of longtime employees, customers, suppliers and other important stakeholders? While the answers to these questions are sometimes conflicting (and can even lead to still more confounding questions!), one thing is certain: When evaluating whether to sell their family business, entrepreneurs must develop a proactive and systematic approach. In doing so, they will not only unlock the inherent company value that has been created over many years, but also will maximize their chances of finding the right buyer for their business.
Patrick Hanraty is managing director of Cobblestone Advisors (www.cstoneadvisors.com), a specialty group of Harris Williams & Co. that provides merger and acquisition advice to privately held companies and lower-middle market private equity groups. Transaction services include private company sales, corporate divestitures and leveraged recapitalizations throughout the U.S. Harris Williams & Co. (www.harriswilliams.com), a member of The PNC Financial Services Group Inc. (NYSE:PNC), is one of the largest mergers and acquisitions advisory firms in the country focused exclusively on the middle market. Member FINRA/SIPC.