The following article by Francois de Visscher was recently published by Bank of America and Family Business Magazine. It outlines the four critical cycles to evaluate when considering selling the Family Business.

 
CapitalEyes

November/December 2007

What to Consider When Selling the Family Business

Imagine a private equity firm calls and makes what seems like a generous offer to fund your next stage of growth. Interest rates are still reasonably low and your industry is booming, so you can command a high share price for selling all or part of the company to the investor. The same week, your nearest competitor calls you via his financial advisor, inquiring about a potential merger of the two companies. A larger size business would be able to compete more effectively in a global economic environment. It seems like a no-brainer: go for it!

Or should you? It depends. From an industry and market standpoint, this may be a great time to sell or invite an outside partner to raise money for an acquisition or, perhaps, for expanding overseas. However, selling the family business involves more than how hot your industry or the financial markets may be. The family business is part of a complicated fabric of business ambition, family values and relationships and long-term wealth-building goals. The patient capital that the family has invested over one or more generations goes beyond dollars and cents; it also involves intangible attributes relating to family heritage and fiduciaries' duties, which business owners are expected to pass on to the next generation. Selling the family business or inviting an outside partner for a large expansion project may jeopardize the ability to pass on the "family effect" to future generations.

Successful Transaction

Any strategic financial transaction for a family company should fit into four different cycles: the business cycle, the liquidity cycle, the ownership cycle and the fiduciary cycle. While these four cycles may not always move in tandem, the success of any strategic financial transition for a family business may depend on how accurately one can time the transaction within the four cycles. Let's look at each cycle.

  • The business cycle weighs the degree to which your company's sector has potential for future global growth. To attract outside capital or a merger partner, you have to demonstrate growth in value and potential global business development. Is your business well positioned to take advantage of growth opportunities in the global markets?
     
    For instance, the natural resources industry currently enjoys global favor because of scarcity and continued demand for energy and resources, while the traditional travel business with its network of agencies and call centers has been challenged by electronic and virtual agencies on the Internet.
     
    To determine whether your company may be attractive to an outside investor or partner, start by identifying the global macro-economic trends (such as global population growth, rising healthcare costs or scarcity of natural resources) that affect your business growth, as well as global threats to your business (such as manufacturing cycles).
     
    Second, consider rise of global competitors, development of new markets and customers in your industry, or even the speed of innovation. What if you conclude that your business survival is in danger in a global economic marketplace? Turn to your company's core competencies, which every business has, and which competitors cannot easily replicate, such as: certain customer relationships, unique manufacturing processes or proprietary sources of supplies. Those core competencies are marketable to an outsider and may be combined with another business, developed in new markets or just bought for value. So even if your business is not quite positioned for global growth, future development of your core competencies may be very attractive to an investor or partner.
     
  • The liquidity cycle gauges the amount of available liquidity and the current appetite of investors to invest in companies, especially those of your size, line of business and structure. A successful transition requires a highly liquid market and access to financial resources — either internal cash flow or outside funds from investors or lenders.
     
    Judging solely by the liquidity cycle, this may be a very opportune time to sell your business or attract an investor or partner. Liquidity is abundant. Private equity firms and hedge funds are flush with investable cash. Banks are eager to lend and have been relaxing their lending standards. Many corporations have accumulated vast amounts of internal cash, as evidenced by the extremely liquid balance sheets of Fortune 1000 companies. All this cash has led to many strategic deals between middle-market family firms and larger companies looking to put their capital to productive use.
     
    Based on the amount of private equity being raised today, the markets should be liquid for the next three to seven years. When liquidity tightens, as it did during the early 1990's, corporate development activity tends to focus on mergers and business combinations as opposed to cash buyouts or investments. The timing of the liquidity cycle will dictate the type of deal that would have the greatest chances for success.
     
  • The ownership cycle considers whether or not this is the right time for the family to sell or to grow with a partner, in terms of what impact the potential transaction would have on the family. Even if the market and industry cycles are well positioned, the family itself may not be ready. Are we approaching or just completed an ownership or management succession? What is the status of family ownership and family management? How spread out is ownership? Has the family already made the transition between business management and wealth management?
     
    In the founder generation, the owner/founder must define the role he or she will play after the transition, which could be leadership of a foundation or other philanthropic initiative that could carry the values and legacy of the founder. That role needs to be defined and prepared prior to the transaction. Without preparation by and for the founder, any attempted deal may likely abort. On the other hand, potential successors may not yet have been identified or prepared. Having outside investors or bankers involved during that future transition would disrupt the succession process.
     
    In the partnership generation, usually the second or third generation, control is shared among descendants of the founders. Some members are active in management, others are not. Active and inactive shareholders must share the decision to sell or to attract outside investors. Their ability to reach consensus depends upon the timing in the succession process. For instance, second generation members who have recently stepped into management will not have had time to establish their own imprint or develop their own strategy, and therefore may not be prepared to deal with assertive outside investors or lenders.
     
    During the coalition generation (typically third generation or beyond), ownership is spread among many cousins/descendants of the founder. In order for them to reach consensus without rupturing the family, the timing of the financial transition has to coincide with the evolution of the family governance. This family governance structure, whether a family council, a family office or even a family holding company, must have the tools to handle decisions about the reinvestment or distribution of proceeds of a financial transaction and the perpetuation of the family values and the family heritage.
     
    One third generation family business that had been approached by one of its competitors for a possible merger turned the suitor down. The family correctly realized the offer indicated the start of a trend in the market for greater consolidation. So instead of selling, the family business' family council rigorously interviewed shareholders about their liquidity needs, attachment to the business, degree of family effect and their desire to pool their assets. They also formed a liquidity committee and an investment committee that helped the family evaluate various financial options to realizing shareholder value. As they saw the right timing in the business cycle a few months later, they were able to handle a strategic transition with serenity and maturity.
     
    No matter what generation, families need a solid governance system to help them make wise decisions.
     
  • The fiduciary cycle focuses on the perspective of trustees and owners with fiduciary duties vis a vis the ultimate beneficiaries/shareholders of the family company. Those owners/trustees have the duty to maximize the value in a trust — not just the business — and weigh how to best invest capital in the trust, creating long-term value as well as liquidity for the beneficiaries by evaluating market opportunities to reinvest the proceeds in order to achieve both return and capital preservation inside the trust.
     
    The fiduciary introduces wealth management into the equation. Even if a potential acquisition seems attractive from the business cycle, liquidity cycle and ownership cycle, trustees focus more on the stage of life of the beneficiaries, and their short- and long-term needs for cash. The owner/trustee would also focus on finding attractive reinvestment opportunities for the after-tax proceeds of the liquidity created for shareholders. In one recent case, the owners/trustees voted against a transaction approved by all the shareholders, because they could not find a reinvestment opportunity for the after-tax proceeds that was attractive enough to provide the desired return for the beneficiaries.

Ideally, all four cycles should align when you're evaluating, as a business owner or owner/trustee, the potential of a financial transition for the family business. If you're not in a good place with any of these cycles, consider what you might need to get there.

There is never a perfect time to effectuate a financial transition for your business. However, by knowing where you are in the four cycles and knowing what to do to improve the timing on the cycles, you may greatly improve your chances for a successful transition.

This article was written by Francois M. de Visscher, founder & president, de Visscher & Co , and originally appeared in Family Business Magazine and also recently appeared in Bank of America's CapitalEyes section of their newsletter.

 
de Visscher & Co.
Two Greenwich Office Park
Greenwich, CT 06831
Tel: 203-629-6500
Fax: 203-629-6547
worldhq@devisscher.com

 
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