Selling the Family-Owned Business

by Steve Sink
Phoenix Affiliates

Having a family-owned business is the dream of most parents and one that most of us can only wish for. Family businesses have served as the backbone of our economy for many years. Consider the following statistics reported by Maine's Institute for Family-Owned Business: Some 35 percent of Fortune 500 companies are family-controlled, and family businesses account for 50 percent of the U.S. gross domestic product. They generate 60 percent of the country's employment and 78 percent of all new job creation.

Due to the large number of family-owned businesses and the important role they play in the economy, there is a tremendous amount of interest in this special segment. Numerous surveys have been conducted to better understand them to improve their chances for success. One of the best is the Mass Mutual Family Business Survey, which does an excellent analysis of planning, growth and succession issues. Some of the significant findings were:

  1. Nine out of 10 heads of the businesses believe their business will be family-controlled in five years.
  2. Forty percent expect a change of leadership in five years.
  3. Ten percent are controlled by two or more family CEOs.
  4. Five percent are headed by women and 25 percent of current CEOs felt that the next CEO would be a woman.
  5. Twenty-five percent of the CEOs have no estate plan.
  6. Only 30 percent have a business plan.
  7. Twenty percent of the heads indicate that 80 percent of their worth is based on the value of the business.

Like any business, members of one that is family-owned face the challenge of perpetuating its success. The business, if successful, has provided a comfortable lifestyle for its members, creating a form of dependency. As long as the business continues to provide the expected lifestyle for its dependents, the business will continue to function as an orderly business. Problems usually arise when that lifestyle is threatened. The threat can come from internal or external forces, or a combination of the two. Given that only one in three family businesses succeeds in making it from the first to the second generation, it's clear they have their own inherent risks.

Each succeeding generation has its own ideas about taking the company forward—or if it wants to join the family business at all. Successful transition has always been crucial to the continued success of family businesses. Many of the concepts that have bound the family businesses have eroded and new sources of potential conflicts have arisen. The sense of duty and obligation to join the family business has weakened, while the sense of entitlement has grown.

"There's always a decent greed factor out there, whether it's between father and son or between established business executives," says Tom Holly, a tax partner with PricewaterhouseCoopers' Private Company Services practice, who works with a number of family-owned businesses. "But I think there's a substantial entitlement discrepancy between the first and second generations." At the same time, Holly says, "I'm not seeing the second generation as actively involved in the business as they were 15 to 20 years ago."

One of the biggest mistakes the controlling owners of a family business can make is not having a definitive transition strategy. It has been widely assumed that the failure of family businesses to survive was due to a lack of planning. In actuality, more recent research suggests four factors that correlate with success or failure:

  1. Failed leadership
  2. The inability to agree on personnel, family succession and the goals for the business
  3. Unresolved conflicts
  4. Failure, by all parties, to communicate.

In short, the owners fail to put the same time and effort into planning and structuring for an internal transition as they would into a sale of the business to an outsider. This failure typically provides the seeds for serious family conflicts. The same issues that would apply to the sale to an outsider must be addressed and clearly defined such as:

  • Financial issues. How will the owners be able to take cash out of the business? Often, the business does not generate enough cash to support the new head and pay the retiring owners.
  • Valuation. Sale prices are often diluted for family members for tax reasons. Outside buyers will pay the fair-market value. 
  • Capability of future generations. Successful transitions to future generations typically require strict guidelines in writing (i.e. MBA, working for a Fortune 500, etc.) and an authoritative, independent screening and evaluation process.
  • Strategic issues. A clear, long-range vision that can be passed to succeeding generations keeps the future owners focused.
  • Flexibility. The business must have a “Plan B” that allows for the sale if and when required.
  • Personal issues. The head of the business must recognize when it is time to retire. This can often be the most difficult to address for the controlling owner and other family members. It is usually best handled by an independent authority.

The sale of a family-owned business can be initiated by competition, internal forces, the economy, lack of a successor and a hundred or more other reasons. Buyers of the business can usually be put
into categories:

  1. Strategic buyers. Will buy for strategic reasons and will usually pay the most. Typically, these are firms seeking market share or find it cheaper to buy a business rather than compete with it. 
  2. Financial buyers. Will buy only if the numbers make sense to them, i.e. a private equity company. They can take a majority or minority position in the company, serve on the board of directors and help the company grow the business. The downside is that the family will have to give up some control, and perhaps, the company if it gets out of the covenants. 
  3. Industry buyers. They know the business because they are in the business. 
  4. Outside professional manager. Hire an outside manager and allow them to run the company.
  5. Inside buyers. Employees or family members are often the most difficult to deal with and will pay the least amount.

The buying process for buyers one through three typically follows a very predictable pattern, i.e. sign a confidentiality agreement, meet the owner(s), ask questions, request information, make an offer, conduct due diligence, secure financing, complete purchase agreement and close on the sale. Number four does not require a sale, but it does require surrendering control.

The buying/selling process for the family-owned business can differ remarkably because of the following reasons or combination of reasons:

  1. There can be multiple family members competing with each other for the purchase.
  2. The controlling owner can be placed under severe emotional stress to choose sides.
  3. The selling price can be seriously reduced because a family member may not have sufficient funds.

Even though lack of planning may not be the major cause of a family business' mortality, exploring all of the options can surely go a long way to sustaining the legacy and providing an opportunity for subsequent generations to preserve the wealth. iBi

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