Family-owned businesses are integral part of the economy, but mergers and acquisitions (M&A) with family-owned businesses present unique challenges. While many families hope to pass their businesses on from generation to generation, other families decide, for a variety of reasons, to sell their businesses. Only about thirty percent of family firms survive to the second generation. Family-owned businesses are a key target for both strategic buyers and financial buyers, like private equity funds. Below are five key issues to consider in M&A transactions with a family-owned businesses.
- Valuation Issues
To successfully close an M&A transaction, the buyer and seller have to agree on a price. However, with family-owned businesses, the buyer and seller may have very different approaches to valuing the enterprise. Family owners may not use customary valuation methodologies, or have an overly optimistic view of the company’s value. Family owners could also value aspects of the business – for example the time, effort and expense of building the business or the business’s contribution the community – that a seller may value differently. In addition, the family may have a target sales price necessary to achieve retirement or financial planning goals, but this price might be inconsistent with the company’s current profile. In some instances a family-owned business may have received valuations estimates from other professionals or trusted advisors involved in the sales process, such as investment bankers, accountants or valuation firms. It may take additional time and effort with the family if the proposed sale price is not consistent with these other valuations of the business.
- Transfer Provisions and Required Approvals
Many family-owned businesses restrict the transfer of company stock in connection with the sale of the business. In addition to transfer restrictions, there may be specific approvals or processes to follow in connection with a sale of the business. For example, there may be contractual rights that require shareholders to sell their shares of the company (“drag along rights”) or provisions that give shareholders the ability to sell their shares if another stockholder sells company stock (“tag along rights”). Transfer restrictions and governance matters may appear in the company’s charter, bylaws or in separate agreements among some or all of the stockholders. These key documents should be reviewed carefully in connection with an M&A transaction. The timing and communications with the owners about required approvals should be carefully considered and planned.
- Operational Transition
If the family has been involved in running the company, the operations of the business may have become overly dependent on the family decision makers. Family-owned businesses contemplating a sale should ensure that operations and management functions are independent of the family, to the greatest extent possible, to facilitate a transfer to an non-family owner. A buyer will likely closely evaluate the depth and breadth of the management team during its due diligence process and the results may impact the valuation of the business. In certain circumstances, family members may also consider being part of the management team after the sale. Both buyer and sellers should fully evaluate the practical impact of the sale, including change in relationship (e.g., from owner to employee) and amount of sales proceeds received, to create a mutually beneficial post-closing relationship.
In addition, certain company assets may need to be carved out of the sale. These assets may have relatively small economic value to the business, but extremely high value to the family. These types of assets may range from season tickets, club memberships, artwork or other items owned by the company with historical or family significance. For example, the family owners in a recent transaction identified historical photographs and community awards that the family wanted to retain to keep for posterity or give to a historical society. The family did not communicate that they expected to retain these assets after the closing and raised the issue with the buyer only a week before closing, which delayed the closing. That said, potential buyers can often underestimate the personal or intangible value families place in these types of assets. These types of requests from the family should be considered carefully.
- Tax Planning
There are two key components to tax planning in respect of transactions with family-businesses. First, how will the sale transaction will be taxed? Sellers should identify early in the sales process if there is a transaction structure that can result in a single layer of taxation on the gain from the sale of the business. Many variables impact what sales structures may be available, including the tax attributes of the seller (e.g., C-corporation, S-corporation, tax partnership) and the nature of the sale (e.g., asset sale, stock/equity sale). Family sellers should consult their accountants and tax advisers early in the sales process to evaluate available tax structures. Potential buyers should also discuss and work with the sellers and their tax advisers early in the process to identify the appropriate structure to avoid late-stage changes in structure.
Second, how will the sale transaction impact the family’s estate planning? Families may have established a variety of trusts or other planning structures that may be affected by the sale of the company. The family owners may receive significant cash proceeds in connection with a sale that may require additional planning or adjustments to its current estate planning. Furthermore, families that have not done significant estate planning before the sale may use the transaction as an opportunity to focus on the family’s estate plan and the family should allocate additional time accordingly.
Overarching all of the issues discussed above, is understanding how to best communicate with and among the family owners. Considering how an issue is communicated is often as important as what is being said. Families may not have gone through the M&A process before and may need to learn the sales process (which may pose additional challenges if there are complicating family factors). There is no one-size-fits-all approach to working with a family through the sale of its business. However, having insight into the family’s reasons for selling the business, the family’s process for managing and communicating the sales process, the family owners’ relationships, who the key decision makers are, and what the emotional impact will be on the sellers all help both buyers, sellers and their advisers manage a successful approach to the sales process.
Family-owned businesses offer great investment opportunities to both strategic and financial investors. If not managed well, though, issues specific to family businesses can easily derail the sale. Both buyers and sellers should work with professional advisors who specialize in sales transactions with family businesses and who can bring a combination of expertise in M&A transactions, tax planning and estate planning. Getting these family-business experts involved early in the sales process – whether as a seller or a potential buyer – improves the chance of a successful and smooth sales process.