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The Evolving Dynamics of Exiting a Family Business

Four steps clients should take before they even consider the possibility of a sale.

Despite the numerous uncertainties that have impacted organizations in recent years—rising inflation, higher interest rates and the COVID-19 pandemic among them—the decision to sell or merge a family business remains fundamentally a microeconomic one. It usually is a function of the family’s circumstances, tends to be less cyclical in nature, and often has much more to do with the life experience of the owner and his or her family than anything else.

That isn’t to say these businesses—and those who advise them—are not focused on the macroeconomic climate or industry market conditions when they consider a transaction. But, in the end, M&A decisions among founder-owned companies tend to be more closely tied to personal lifecycles than external factors. According to AARP, nearly half of all baby boomers (45%) consider themselves “entrepreneurs.” With about 10,000 of them reaching retirement age each day, it’s no surprise that many are motivated to consider a sale regardless of market conditions.

One recurring trend we have seen over the past several decades is that for many family-owned enterprises the next generation has shown little interest in taking over the business. As sons and daughters of founders choose to pursue their own career paths, founders and their wealth and business advisors have to think more creatively about possible pathways as they seek an exit.

Here are the scenarios and drivers we most commonly see when we interact with family business owners facing this critical juncture:

  • The business owner is nearing retirement age;
  • Succession issues are complicated (e.g., children not involved in the family business or capital needed to effectuate a succession plan);
  • An unsolicited offer to buy the company has been received;
  • There is an upcoming requirement for a large capital investment (such as new equipment, real estate, technology, etc.);
  • There have been changes in the owner’s health or marital status;
  • The owner is motivated by news of a transaction involving a major competitor, customer or vendor; and
  • Regulatory issues from recent changes or enforcement have made a sale more attractive.

All of these scenarios have the potential to produce a great deal of uncertainty and apprehension. For founder-owners and families, it is often the most important financial decision of their lives. For advisors consulting with their business owner clients on the best path forward, there are four things they should encourage their clients to do before they even consider the possibility of a sale:

  1. Get the Financials in Order
    • Buyers and their lenders evaluate financial statements in a very prescribed way. At minimum, business owners should have a full inventory of monthly income statements, a view of the balance sheet and statement of cash flows prepared in accordance with GAAP, utilizing the “accrual method” of accounting. Buyers will review financial statements and prepare their own analyses during due diligence. That’s why presenting accurate financial statements is more important than whether they are currently audited, reviewed, compiled or internally generated.
  2. Continue to Invest in the Business
    • Signaling to the buyer that the business has been properly reinvested in and maintained at the highest level is important. Though it’s tempting to avoid making large capital expenditures in the years leading up to a sale, a business will fetch its highest valuation when properly invested in, be poised for future growth and allow the new buyer to execute its growth strategy without having to “ding” you for underinvestment in recent periods.
  3. Create a Three-Year Forecast
    • Setting achievable goals and highlighting the company’s competitive position will give buyers a better idea of how the company can grow and excel under their ownership. The projected numbers should be achievable in the proposed period. It is far better to underpromise and overdeliver.
  4. Focus on Sales and Growth
    • Any prospective buyer is going to look closely at the growth potential of the business. Therefore, prior to and during an M&A process, it makes strategic sense to work on growing sales efforts, which may mean hiring additional sales reps and increasing the overall investment in growth initiatives. Think of this like renovating the kitchen before selling your house—you’ll command a higher price if it’s a nicer property.

Most family-owned businesses are private partnerships or single-owner/entrepreneurs. Because they have been laser-focused on building and running the business, founders are often less familiar with the nitty-gritty details of their financials or what factors come into play in selling or merging a company. But by taking steps to get the business prepped for sale, and understanding what prospective buyers are looking for, they can increase their likelihood of a positive outcome.

In the end, it’s all about helping the business owner and his or her family realize the greatest benefit, while giving them a sense of satisfaction that they’ve arrived at the right outcome.

Chris Parisi is a partner at Carl Marks Advisors.

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