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The future of the business

Preparing for a sale or exit of a family business

"Parting with your family-owned business is no less difficult than an artist parting with their favourite work. It is your masterpiece and, often, your life’s dedication and maybe that of previous generations as well. With some planning, you can help position your business to attract buyers. In this instalment of our series, “Pivotal moments for family enterprise”, we set out a number of considerations to assist you maximise the value of your business and protect wealth for future generations."

When you create something great, it can be tough to let it go. Just as with an artist, it can be even tougher to sell to someone you think will not value it as much as you do.

It is a conundrum familiar to many family business founders or owners who have worked so hard to realise their vision and cannot imagine it in the hands of someone outside the family. In our global survey of family enterprises, only one in 10 respondents saw an outright sale to a third party or an initial public offering (not discussed in this article) as preferred options for their company’s succession. In a separate Deloitte survey, 63% of next-generation family business leaders surveyed said it was “very important” or “fairly important” for the family business to own intellectual property.

But the life cycle of family business ownership is complex and decisions to exit, in whole or in part, are often driven by individual family members’ wants and needs:

  • The next generation may not be interested or prepared to take over.
  • There may be multiple family members involved, some with different aspirations.
  • Some might want to grow the business while others seek to cash out their stakes.

If a sale is contemplated, the level of preparedness will impact the level of interest, valuation and terms received. Understanding the options ensures shareholders are best placed to choose the one that is best for the business and them as individuals.


Balancing succession and control

In past publications, we have underscored the importance of building internal alignment between the family strategy and the business strategy to create a shared view of the future. This process may become even more complicated when considering succession along with a liquidity event which impacts control.

Succession - There may be few family candidates who are realistically able to lead the business and sustain multi-generational success. Understanding who is ready and willing to step up well ahead of time helps the development of future family leaders. If there are no family members willing or able to pick up the reigns, then a simple solution is to buy in (and motivate) talent. The family retains control. With or without external management, the family must be certain it has, and is aligned on, the capital resources to maintain and grow the business.

Control - In the alternative, a liquidity event can assist with the succession but may dilute control. Clearly an outright sale means the family loses control, but may well remain in the management team, at least for the short term. It has the added benefit of diversifying the family’s asset base, often a consideration for trustees where a number of family members are beneficiaries of a trust.

But there are alternatives which provide liquidity for growth or to release capital but with less loss of control: sale of a cornerstone minority shareholding or introducing debt, subject to existing levels. When it comes to either debt or equity investments, there are different ways to structure the transaction. For equity, in addition to minority equity stakes there are other options, such as debt that converts to equity. Any which way, the ‘sale’ of equity requires one or more or all shareholders to be diluted.

Irrespective of it being equity or debt, the family will have to make control concessions around the operation of the business: money always comes with strings, even if it is enhanced external monitoring.

When family members express an interest in divesting the company or just their stakes, the rest of the family needs to understand their reasons. Sometimes a third-party intermediary can help the family explore their individual and intergenerational needs, look across the capital structure and offer a perspective of what could be possible based on the amount of liquidity required. In addition and to assist with ownership changes, families may have buy-sell agreements in place that designate the price for the internal transfer of equity.


Readying for a transaction

Many businesses only start preparing once the possibility of a sale is on the table: preparation for a sale should start years beforehand. Ideally, the company is always ready for sale as one never knows when an approach, or the need for equity, will materialise.

Being prepared means that issues that might have an impact on value are addressed prior to due diligence. Here are four preparatory steps family business leaders may want to take before considering a whole or partial sale.

Often easier said than done, but thinking about your business from a buyer’s perspective will help you understand what they are looking for: is it a beachhead or platform investment, complimentary bolt on in either the same or an adjacent market or is it a synergy play?

Whatever the rationale, a ‘Readiness Review” is key to ensuring that you have thought about things from an external perspective and given yourself the best chance of identifying potential issues. Almost without exception and no matter how well a management team thinks it understands its business, there will be issues that come to light during due diligence of which management was not aware.

Many entrepreneurs achieve success through a blend of smart financial management and gut instinct. Buyers will be far more interested in the former.

The quality of a business’s earnings tells them which aspects of the company’s financial performance are repeatable and which are non-recurring. Together with revenue and GM%, maintainable EBITDA is one of the first metrics on which buyers will focus. Far better that you make that assessment than let a buyer do so. Any change in maintainable EBITDA will alter the valuation: buyers tend not to tell you about increases!

Where you are including forecasts, even a current year outturn, buyers will be looking for justification for them, particularly where significant growth is expected and / or there are new business units or markets where there is a limited track record.

Management will need to ensure that the business’s reporting systems are accurate and provide the kinds of insights or metrics a buyer would need to understand the business fully. With sufficient forethought, there should be time to invest in business intelligence / forecasting tools that will improve the financial reporting / forecasting and analysis.

Tax matters can have a significant impact on value in a transaction. Sellers should fully understand and be able to clearly explain the business’s legal entity and tax structure, tax filing profile and potential tax issues to a potential buyer.

For instance, a business that may not have strong tax governance processes may result in a buyer’s due diligence uncovering and adding previously unreported tax costs. A thorough review might also uncover potential tax-specific value drivers (e.g., opportunities to obtain a step-up in tax basis or attributes that may be available to offset future taxable income) connected to the business or the assets being sold, thereby boosting the value for a buyer but which may not be factored in from the seller’s perspective.

To help spot these potential issues and opportunities, family enterprises should consider undertaking a vendor due diligence that reviews the tax profile of the business being sold. This exercise can result in the forward identification of potential tax risks, allowing these to be mitigated upfront (e.g., amended return filings, voluntary disclosure agreements or method changes) or could give rise to potential structuring alternatives that may be mutually beneficial to seller and buyer, allowing the seller to benefit from this as well...

Wealth planning is as important as preparing the business for sale and closing the deal when it happens. Often family enterprises have had most of their capital tied up in the business and are not used to managing passive investments in the same way. Just as they planned for business success with a vision and strategy, they should be forward planning for how they will manage the proceeds so they continue to provide accretive growth to the family wealth.

Depending on the specific circumstances and the quantum of the sale proceeds, families may wish to evaluate setting up a family office to manage the family’s new liquid wealth and determine where to invest it in line with the family’s goals and values. (We will add more to this topic in our final upcoming article in this series on family office creation).

Planning the process

A complete or partial sale is a big decision particularly for families running a business together. The decision making process that leads to the conclusion to step away from your creation can be emotional. Those ties run even deeper where there is a multi-generational history. However, once a decision has been made, a fact-based, disciplined evaluation and preparation helps you present the business in the best light to maximise the value achieved.

Your adviser will help plan the process: that plan should cover matters such as how broad a process you run, do you undertake vendor due diligence, is the deal to be insured and what are your non-negotiables.

Questions to ask when considering a sale or other capital-raising transactions

Next up: “Family office creation” will explore the considerations for starting a family office—such as operating costs, partnerships, proper controls and investments and roles and responsibilities—and how to form a family office that meets your family enterprise’s needs.
Click to read more articles in the series

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