Capturing wealth via a sale of the family business
Planning for the future of your family business can be one of the most challenging tasks for the family; it is also one of the most critical. One of the most difficult decisions for family business owners is whether to transition the business to the next generation or to sell it.
Regardless of the size or age of the family business, considering its sale can be extremely emotional and sometimes divisive. The business is often the result of years, or even generations, of a family’s hard work and devotion. The family’s past role in the business may have created expectations about continuity, tradition, community activities, dividends and even family employment. Often the business also serves as a source of family unity. However, the owners, the board and the family council must take the responsibility for succession planning and preserving the value created by the business. This sometimes means making the difficult decision to sell.
There can be significant costs if the family fails to recognize when it is time to sell. And, in the current economic climate, a sale may take significantly longer to accomplish, requiring a longer-range perspective.
Should we sell?
When a family business is involved, the decision to sell requires much more than an economic analysis. The emotional consequences of such an action can be greater than the financial impact. Here are a few issues to consider:
• Is the timing right? Today, while the market for M&A has improved, we are by no means out of the woods; adverse factors persist. In most industries valuations likely will increase slowly, if at all; there are fewer buyers, and financing is tighter. Don’t expect dramatic increases in valuation over the near term, unless your business shows significant growth or is in a “hot” sector.
Often, advisers will recommend a sale if they feel the potential for the future growth of the business has faded. A slower growth curve, a decline in sales, significant challenges from a large competitor or the development of competing technologies may be your signal that it is time to consider selling.
You first must do your homework and determine a range of likely values for the business today. Then it is important to make your best guess as to whether, and how much, these values are likely to change over the coming years. This analysis requires a critical look at the current state of the business as well as a careful study of the industry and the external factors that may affect its future prospects. You should also consider whether the family’s assets are sufficiently diversified. If most of the family’s eggs are in one basket, you should seriously consider whether a sale or other transaction is a prudent way to reduce this dependence.
• Succession issues/family conflicts. Because selling is an emotional as well as a business decision, the family must honestly discuss the available alternatives and their implications. Perhaps the younger generation is not as interested in carrying the torch, or family members have developed such divergent views that a smooth transition to the next generation is next to impossible. Would the business prosper if only some of the family were bought out, or if professional management were brought in to supplement or replace family leadership?
Managing the different views of all the stakeholders is a challenging but integral part of the decision-making process. If this process is ignored or not properly managed, it can lead to controversy, bitter feelings and even deadlock, any of which could make a sale inevitable, whether or not most family members want to avoid that outcome. If the family can agree on the internal issues and expectations, it may be able to produce a solution that works for everyone and ultimately even enhance family harmony.
Another important issue is burnout. When a family is in business together, there often is no respite at work from family issues, and vice versa. And, on the other hand, while some can sell their business and never look back, many people have sold their companies without adequately planning what they would do next. Boredom, disenchantment and regret often follow a sale.
You should consider the impact of the sale not only on your family members, but also on the communities where the business operates, its customers, employees and other constituencies. Once the business is sold, the family will likely lose control over factors such as product quality, workforce and reputation. Consider whether this separation will be acceptable and, if so, how you will prepare for it.
• Capital concerns. At the end of the day, businesses fail because they run out of cash. Looking down the road, you may be able to identify substantial requirements for capital that will be needed to adopt a new technology, expand or capture market share, or simply remain competitive in a rapidly changing environment. If it is not clear from where the business will obtain these funds, it may be reasonable to consider selling the business. Raising capital and investing it in your company can involve a significant execution risk. Even if well executed, and the capital deployed as contemplated, the plan may still fail because of factors totally outside of your control.
Preparing to sell
If you decide to explore selling, both the family and the business must be prepared for the process. This preparation includes the following steps:
• Pre-deal assessment. Preparing for a sale involves a significant degree of personal planning, including an assessment of the potential tax and estate planning consequences and the family’s expectations and goals. It is important to select advisers such as investment bankers or business brokers, tax advisers, estate planners and experienced M&A counsel and accountants who can help guide the family through this process.
Next, the company should review any inside deals and assess its state of corporate and financial housekeeping. This step involves identifying and quantifying any “side deals” and informal arrangements with family members. You should document or perhaps eliminate any off-market employment or other arrangements with family and friends, and qualify any material off-balance-sheet contingencies. If not already done, consider having your accountants prepare a full GAAP audit of the company’s financial statements. If a total cleanup is not practical before the sale, the company should be at least be able to identify and quantify this type of information so that potential buyers can understand the impact of these arrangements.
• What kind of buyer? Buyers generally come in two flavors: strategic and financial. Strategic buyers are already running a similar business, or are in an adjacent industry. They typically know the industry, the customers and the risks and upside potential of your business. Because they generally have similar operations, a transaction with a strategic buyer often allows for “synergies” in an acquisition, which may mean the elimination of overlapping employees and operations. A financial buyer is a financial investor who may not know your industry well but is looking principally for a financial return over five to seven years.
Strategic buyers often have a reputation for moving more slowly than financial buyers but may be willing to pay more for the business because of the strategic advantages it can bring, as well as the opportunity for cost savings achieved through consolidation. This consolidation may include layoffs and restructuring that could be far more dramatic than would typically occur with a financial buyer. Consequently, you should consider the impact of a sale to a strategic buyer, and any consolidation activities, on your community, your employees and your family’s values. On the other hand, if any of the current owners would like to continue to invest in the business, financial buyers are often willing to allow you to retain an equity stake in the business, at least for the duration of their investment. This generally is not possible with a strategic buyer.
• Due diligence and disclosure. The due diligence phase can be critical to obtaining the appropriate value for the business. In addition to the buyer, due diligence requests will come from potential financing sources and the buyer’s advisers. The goals of the due diligence are for the buyer and its financing sources to understand the company, its future prospects, business plans, position in the market and management team, and the risks and upside associated with the business and the industry.
Potential buyers will ask for extensive detail on a seemingly endless list of items. Documents requested typically include customer and supplier contracts, financials, projections, organizational documents, intellectual property and licensing arrangements, and information on environmental compliance, employees and employee benefits, taxes and litigation. It is usually preferable to build your buyer’s confidence early by disclosing existing or potential problems than to wait and surprise the buyer late in the process. Buyers may want to talk at some point to customers, employees and suppliers.
In order to respond to requests for information, you should develop a process to handle due diligence. Confidentiality is particularly important during the sale process, since if word leaks out it may be unsettling for employees, customers and other constituencies, and competitors often use this information to try to take customers or hire away key employees. These issues are particularly important if you are considering a sale to a competitor. It is also important to have a consistent storyline for those without knowledge of the deal, including customers and suppliers.
• Communicate with stakeholders. Communication about the sale is critical to a successful transition. While the buyer should communicate to you its expectations regarding changes to the business, you should be communicating with the family, management team, employees, customers and suppliers. The communications strategy should be planned early—well before the deal is signed.
A good communications strategy will help the family, management and key employees to buy in to the deal. To do so, it must be delivered in a controlled, timely way, aligning the key messages of buyer and seller and planning for uncertainty, including contingency plans. It also should address the risk that customers and employees may hear the news from outside sources (e.g., competitors or the press). Part of the communications strategy should be to develop standard responses to “Frequently Asked Questions.”
Planning is essential
Deciding to sell the family business is a complicated process that requires careful planning, consensus building and a frank consideration of the family’s own strengths and weaknesses. Most of all, it requires thoughtful and effective communication. A successful sale can be the solution to many family concerns, such as succession and wealth management, or it could dissolve the ties that bind the family together. Paying attention to the signals you are receiving and taking the time now to plan for the future of your business are crucial first steps.
Doug Raymond is a partner in the Corporate and Securities Group at the law firm Drinker Biddle & Reath LLP (www.drinkerbiddle.com). This article was written with assistance by Ena Lebel, an associate in the firm’s Corporate and Securities Group.
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