Small businesses have long been a strength of the U.S. economy. According to the U.S. Census Bureau, in 2014, 61% of the over 7.5 million U.S. businesses had fewer than 10 employees. Family businesses have long been acknowledged as the leaders for growth in most industries, including Food and Beverage, Agriculture, Retailing, Broadcasting and Media, etc.
Once upon a time, entrepreneurs dreamed of starting a business that they could pass on to the next generation. However, a recent study by the consulting firm PwC found that interest among owners to pass the company on to the next generation is declining. In fact, among family-owned establishments anticipating an ownership change within the next five years, only 52% plan to keep the business in the family — down from 74% just two years ago.
Some of this change is attributable to factors over which owners have little control. These can discourage continued family ownership (consolidation, need to reinvest in new technology, etc, regulation, taxes). Industry market conditions also often make it more difficult to maintain or build long-term value. More than in the past, millennials and the next generation of owners have diverse interests and may not want anything to do with the family business.
In order to plan a family’s options for the future, several key steps are required:
Understanding Fair Market Value
Our experience is that owners seldom know the real Fair Market Value of their business. Some tend to be overly optimistic and believe the business is worth more than it will likely generate – even in a professionally managed, competitive, sale process. Some only look at current earnings as a barometer of value without considering the risk and uncertainty of the future.
Most owners are understandably emotionally attached to the business they built and that has provided their family with a comfortable lifestyle. As such, it can be hard to hear that the business has less transferable value than they anticipated.
Performing a Current Assessment of the Business, its Management, Industry, Market, Financial Condition and Outlook
We often are asked to provide family businesses with an operational assessment that includes a SWOT (Strengths/Weaknesses /Opportunities/Threats) analysis, and benchmark comparisons with similar companies, including competitors.
In order to grow value, owners must recognize the value drivers and detractors of the business, as well as identify future opportunities and risks.
According to the PwC survey results, only 23% of firms have a well-developed and documented ownership transition or Exit plan — down from 27% two years ago — and nearly one-third have no plan at all. This is unfortunate in that poor or no planning can adversely impact a family for generations.
The best plans are in fact two, one that provides for an exit with liquidity for some family members and one that creates a road map for growing shareholder value for those desiring to remain invested.
A Growth Plan for owners desiring to remain family-owned for the long-term, requires tough decisions regarding governance, how the business is to be managed, and the role of family. These decisions require careful consideration and the opinion of experienced advisors outside the family. Even then they can create friction and resentment among the family.
The best private companies hire non-family managers who manage the business as if it were a publicly-owned entity with the primary focus on building value rather than providing “perks” for family.
Never too Late
The time to start planning of a family business was yesterday. Delay can result in unforeseen problems that are expensive to remedy.
A good Growth and Succession plan will maximize value AND provide for an orderly transition of ownership. The process should offer flexibility, treat all parties fairly, and should be conducted over a sufficiently long period of time to fully realize the benefits of operational changes that may be required.
Retain a team of professionals experienced in planning for family businesses. At a minimum, this should include a tax and legal advisor, and an experienced investment banker knowledgeable in valuations.
Develop and implement a strategic Growth and Exit plan initiative several years before transitioning the business. Without planning, there likely is not enough time to fully realize the benefits of operational changes. Generally, we like to work with owners three- five years or longer in advance of any transition in ownership though circumstances can dictate differently.
“Choosing an advisor to represent your company in a significant purchase or sale transaction might be the most important decision you make in business.”
As a CEO or business owner, a sale of your business or purchase of another entity is a risky matter. Surveys have long shown that most deals fail to produce the results either party expected.
For sellers, a sale or merger is often a one-time opportunity that can create liquidity and financial security. This can allow for an orderly, planned transfer of wealth from one generation to the next or to a chartiable organization(s).
Statistics have shown that a qualified M&A advisor can add as much as 40-50% to the price for a seller, and for buyers and sellers, greatly increase the odds of closing, a smooth transfer of control, and a win-win for all.
For a buyer, an acquisition(s) can increase shareholder value more quickly than organic growth alone. If managed well, the purchase can produce multiple benefits. If not, the results can be disastrous.
Most buyers are very experienced; few sellers are. Large private and public companies would never enter into a major transaction without professional assistance and a formal plan.
The M&A advisor should possess the following qualities:
The advisor should provide:
Here are some questions to ask before hiring an advisor:
“What services do you offer?”
A professional advisor should perform the following services in every engagement:
Often the advisor must also:
“Who offers M&A Advisory services”
Many firms and individuals claim to be “experts” at advising on the buying or selling of a business.
The shareholders of large public companies almost always rely on Wall St Investment Banking Firms for advice regarding a significant transaction. These firms may assign 1-2 senior people and 10-20 junior bankers to a project and their fees are usually in excess of $1 Million.
Some National and Regional Commercial Banks offer "Capital Market" groups that advise smaller public and larger private companies ($100 Million +) and charge fees similar to the large Investment Banks. Their goal is to create liquidity for an owner which then can be directed to the Bank's "Wealth Managers".
Larger "Boutique" Investment Banks of 20-50 professionals are common and often are owned by alumni of the larger firms and Banks. They also assign most work to junior bankers but seek fees of $500,000 per engagement.
Smaller "Boutiques" often specialize in an industry or a target market (Region, deal size, etc). Their owners may be former CEOs or CFOs, Academics, or former Corporate executives.
Some law firms and accountants also offer M&A consulting services. Their professionals may or may not have business management experience and the overall understanding of all aspects of a business.
Regardless of the size transaction, a M&A advisor should have extensive experience in many industries over many years, and knowledge in all parts of the deal business, legal, accounting and management. Preferably, they should have owned or managed businesses themselves and understand/appreciate the impact that a deal can have on people.
“What transactions have you completed?”
Experience is as critical in making a good deal as a skilled surgeon is in healthcare. Look for an advisor who can provide a list of their completed transactions and references. While an advisor's specific industry experience can be a plus, sometimes it leads to conflicts of interest and may result in the advisor following a familiar path and seeking a quick and easy solution rather than doing the research and hard work necessary to maximize value.
The size of the advisor’s completed deals is also important. An advisor who has brokered two $600 Million acquisitions for Google is not likely a fit for you if your company is worth $10 Million. Neither is an advisor that has never sold a business with a value over $2 Million.
“What is your transaction process?”
Every advisor should demonstate a disciplined, fully documented, formal “process” for managing deals. Each transaction should include deliverables, benchmarks, and a timetable.
“How much time will be required of me and my employees?”
The sale or purchase of a business can be a very time consuming process that can take 12 months or longer to close. CEO’s going it alone report that it can require 70-80% of their time for many months. This is time away from their business and customers and greatly increases the liklihood of losing confidentiality.
One of the advantages to hiring a professional advisor is that they handle all the details. Visits to your business are not permitted, managers and employees are not distracted, and customer/vendor relationships are protected.
“Are there alternatives to a sale?”
There are many alternatives to a merger, acquisition, or sale. Strategic partnerships and joint venture agreements are common, can be relatively simple to negotiate and structure, and if necessary, can be unraveled rather quickly. An advisor should have experience in strategic agreements.
“How do you find prospects?”
There are buyers for every company. The key is success is to find the RIGHT partner. There is no chance that even the best advisor will have a relationship with all. They should, however, have a process for researching, identifying, and qualifying targets. Always ask about their research capabilities which should include access to proprietary databases, personal interviews, and specific industry knowledge.
It's also important to ensure that the advisor has access to both strategic and financial buyers. These groups have fundamentally different objectives, which affect the deal terms as well as the post-transaction dynamics. In a sale to a financial buyer, the seller's management often continues running the day-to-day operations. A strategic buyer often has their own management.
“Who will be the people assigned to my engagement”
Larger M&A advisory firms have a few seasoned executives at the top pitching their services with younger, less experienced “associates” actually managing the process. Some firms even hire attractive marketers to recruit clients who have never closed a deal.
Be sure to ask who the individuals are assigned to your project and what is their experience.
“What about academic and professional credentials?”
The deal business requires a high level of education, experience, commitment, discipline and excellent communication skills. Basic academic credentials require a business education and a strong financial background (such as a MBA or CPA). A MBA, however, is no guarantee that the individual has the practical experience, patience, motivation, persistence, and determination to get your deal closed.
Seek a firm that includes not only strong financial people but also seasoned executives who have run businesses themselves or served at C-level positions. They are more likely to have the “street smarts” necessary to deal with the people issues in every deal.
“What about confidentiality?”
Maintaining the confidentiality of the negotiations is extremely important. It can be damaging to a business for key employees, customers, or competitors, to prematurely learn of a sale. Rumors often result in failed negotiations. Your advisor should never agree for you to meet with buyers directly or in your place of business until they have been qualified and basic terms negotiated.
“How many of your past engagements did not close and why?”
This is an important question and one that every Company should ask. Have the advisor walk you through their recent transactions that did not close and the reasons why.
“Can you provide references?”
Ask to speak with several past clients of the advisor. When you connect, ask about the people assigned to the project, how long the process took, how confidentiality was preserved, and if the owners were satisfied and received value for the fee paid.
“What is the value of my business?”
Valuation is usually the most important consideration in a transaction. Buyer and Seller alike should enter the process with some knowledge of values and reasonable expectations. Other factors include terms, representations, warranties, non-competition, management and consulting agreements, etc.
The advisor should have knowledge of current values, provide guidance on pricing and understand the customary terms in a transaction agreement.
“What are the fees for investment banking services?”
Unlike CPAs and attorneys who normally charge based upon an hourly fee, an M&A advisor’s fees should always be based upon successfully closing a transaction. This puts their financial interest in alignment with the client and provides a strong incentive to perform.
Most M&A advisors charge an upfront or monthly “retainer” which covers the advisor's hard cost of the business review and valuation, research, preparation of the pitch materials and preparation of the target list of buyers. The retainer is sometimes credited against the success fee.
Retainers also serve to demonstrate a commitment that the client is serious about making a transaction, will be reasonable, and the advisor is not spending time and money working on a project where the client is simply trying to get a “test drive”.
Upon a closing, the banker receives a success fee which is based on industry standards and which can range from 1-10% of the value of transaction, depending on the size of the transaction and other factors. Travel expenses are usually approved by the client in advance and are reimbursed.
Often the advisor must provide consulting services in order to prepare a company for a transaction. In these cases, they charge a flat monthly fee or an hourly charge.
In all cases, clients remain responsible for all other professional fees including legal, accounting, etc.
“How much time does the process require?”
Although deals have been closed much quicker, a professionally managed sale process can take 6 to 12 months.
“Are there any third party approvals or regulatory issues?”
Lenders almost always reserve the right to approve the liquidation, merger or sale of the collateral bulk assets of a seller’s business. In addition, some shareholder agreements contain buy/sell provisions which grant shareholders rights of first refusal. State law governs the bulk sale of assets which require certain notices to creditors. Some transfers require other third party consent such as government contracts.
State and Federal laws regulate the sale of securities and parties authorized to represent firms in a transaction. Recent changes have eliminated many regulatory issues in the sale of a private company. In some states the sale of business assets, including real estate, has to be managed by a licensed real estate broker.
The purchase or sale of a business is a serious matter that can be complicated, which is why many deals never close. Due diligence can be painful and time consuming. The right advisor should have a unique combination of deal experience, a track record of success, communication and transaction skills, integrity, and the time and commitment to your project.