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Viewpoint: Is your client’s would-be deal for real?

By Paul Schaye – 5 April 2007

Some of your clients own family businesses. In many cases it is the primary source of their wealth, and the principal focus of their lives. That makes selling a family business a high-stakes proposition. In addition to the possibility of a significant liquidity event, it can also be an emotionally charged, psychically draining process. So when called on to advise family-business owners on selling, it is handy to have in mind ways to help them evaluate potential buyers.

A matter of process

What does the prospective buyer plan to do with the business? Do they care how much of your client’s emotional capital is invested in the company? Will longtime employees — some perhaps the owner’s relatives — be treated with respect or pink-slipped as soon as the deal is done? And can the would-be buyer actually close the deal or will he leave the owner hanging?

Most family businesses leave the family. Less than a third of them reach a second generation, according to the trade journal Family Business Review. Only 12% are still viable into a third generation. A mere 3% survive into the fourth generation. Many of these businesses are owned by entrepreneurs born shortly after World War II who are ready to retire but do not have next-generation family members who are willing or able to take over.

The good news is that there is plenty of money chasing after businesses. The issue is not the “green” available but whose green the family-business owner should take.

Fortunately, when selling the family business becomes a consideration, there is a logical way to work through the process — and remember that selling is a process, not a single event.

Encourage a family meeting

All the key stakeholders should be on the same page. Before they consider a buyer, have them get together and determine the main reason for selling.

  • Is it because many of the stakeholders are getting close to retiring?
  • Is ill health among key owners causing a disruption to the business?
  • Are there changes in the marketplace that family members are unable or unwilling to keep up with?
  • Does the family need cash to fund pursue a totally new business venture?

The possible sale of a family business can be viewed in very different ways by family members. Some may see it as a way to move forward; others may view it — no matter how potentially remunerative — as a failure. Selling a family business should be done for reasons that everyone can buy into.

If, for example, a family-owned company that makes toys in the U.S. comes to realize that to remain competitive it has to start manufacturing overseas, it might in fact be time to consider selling it. The question would be: does this family’s business leadership know enough about the dynamics of international production to make it happen?

The family should set out agreed-on priorities to guide negotiations with potential buyers. This should cover questions like:

  • How important is it for the company’s legacy to continue?
  • Are they interested in a total buyout?
  • What about a partial buyout?
  • Would a minority investor solve the problem of cashing out part of their equity and still allow them to run and grow the business?
  • Should the family sell part of the business outright — perhaps a portion of the enterprise they are less interested in running — and retain the rest?
  • What is not negotiable with regard to keeping personnel, maintaining relationships with vendors and ties to the community?

The family should also choose the right person to negotiate. The best lead negotiator may not be the founder or even another family member. It could be a CFO brought in from the outside. Bottom line, the negotiator should be the person best qualified to speak on behalf of all stakeholders.

The family’s goal in planning is to convert subjective family sentiment into an objective course of action.

Buyer background check

Knowing whether a buyer is for real takes due diligence. Family-business owners need to take time to research potential suitors. A member of the family can check the buyers’ references, but it’s wiser to bring in outside professionals.

Advise the family to speak with their attorney about a confidentiality agreement that they want buyers and others involved in a possible transaction to sign. If employees, customers and vendors get wind too soon of the family’s intention to sell, it can wreck the process. And, as the saying goes, you can’t unscramble a broken egg.

An M&A specialist can handle the logistics of evaluating the buyers. Have the family consider not only the past transactions the specialist helped bring about, but ask how the specialist’s valuation of the companies compared with the final sale price of the businesses.

Ask the buyer for a snapshot of deals from at least the past three years and request at least five references that reflect the type of transaction that might take place with their business. When checking these references, there are questions to keep in mind to help the family determine the potential buyer’s legitimacy.

  • Was there anything they promised beforehand that the buyer reneged on after the transaction?
  • If they continued doing business with the buyer after the transaction, how comfortable was the working relationship?
  • How smoothly did the buyer handle the transition with various stakeholders including employees (especially retained family members), customers and suppliers?
  • If you had to do it all over again, would they work with this buyer?

One of the most effective background check techniques is to conduct a reverse site visit. It’s assumed the buyer will want to inspect the business facilities. However, request that family members be able to visit the buyer’s offices and schedule meetings with as many key people as possible. In particular, connect with the people who will sign the final documents.

Advise the business owner to watch for extremes in demeanor: too much optimism or too much pessimism.

The overly pessimistic buyer is likely to mention things like future market conditions, the age of the business’s infrastructure and perhaps the need for post-transaction retraining of current staff — all to justify a lower offer than what the owner believes the business is worth. The buyer may even use research and documentation to back up all these claims. However, it’s like arguing a case in court: each side can draw opposite conclusions from the same evidence. It’s the responsibility of the business owner to consider the buyer’s research and to do some of their own.

There can also be a downside with an overly optimistic buyer. The buyer may be timing the purchase to another transaction and so try to rush it along. That might not be all bad, but if it doesn’t match the family’s timeline for the sale it can create problems. The buyer may also become overly optimistic about the valuation. That could be a ploy to distract the family from other critical negotiation points such as retaining family members as employees after the sale.

Because every business has a culture of its own, it may also be advisable to conduct a “personality” evaluation on potential buyers. This can be done by getting answers to a checklist of questions such as:

  • What is the buyer’s communication style? Do they dialog or dictate?
  • Does the buyer desire to understand the business’ history and its current position in the marketplace or do they see it as just another financial statement?
  • What is their understanding of transactions with family owned businesses?
  • Have they grasped the motivation and goals of the company?
  • Have they internalized the owner’s concerns with post-transaction issues in dealing with staff, customers and suppliers?
  • Do they volunteer to share their entire track record, even some negative experiences?
  • If the business is a major factor in the local economy and community involvement, do they show a sincere interest in continuing that tradition?

The last question can be important to some family-owned businesses. Often they see their communities as stakeholders. After all, without the community’s support — as a patron, a source of labor or both — some businesses simply would not exist.

Like it’s your own

Taking the step to sell a family business is a big one. After the transaction takes place, the family business owner may have little interaction with the buyer and perhaps little or no control over the business. As an advisor to the family, be as diligent and careful throughout the sale process as you would be if you were selling your own business.

The transaction you help to create will have strong emotions tied to it and the consequences of a negative experience could be far reaching. On the other hand, a positive experience can help make the relationship between you and your client last for many years to come. –FWR