The Family Company
Article written by Tony Mead, Senior Partner.
Family owned companies are often assumed to be small businesses which pass from generation to generation. Sometime they are, but many also global companies and international brands. In reality two thirds of companies globally (as reported by the Family Firm Institute) are family-owned and responsible for upwards of 70% of global GDP. They include such household names as IKEA, Wall Mart, Volkswagen, Berkshire Hathaway, Tom Ford, and Nike. These businesses differ from those which are not family-owned in many ways including management style and capital structuring. They have their own issues that need to be understood by the professionals advising them.
Such companies are often run by the founders or their close family who are people passionate about the business. As such they enjoy greater freedom than those more accountable to external investors, or their bankers. Some companies have acquired independent boards and some have a proportion of external or in some cases public ownership although the founders continue to exert considerable influence by virtue of substantial shareholdings held through different holding companies. Both IKEA and Zara are such examples. Having fewer external constraints these companies are frequently more profitable and other non-family companies. Indeed, they often carry far less debt and enjoy the benefit of the perspective of several generations. Strategic decisions can be made quickly. They tend to invest more in R&D, acquiring and retaining talent so the loss of key players is lower.
The CEO does not need to appease external shareholders with quarterly profit figures to the extent of other companies and therefore the board can have the luxury of taking a long term view. This, combined with a solid capital base enables them to outperform non family owned businesses by significant amounts. In a recent report by PWC, 60% of UK family companies were showing revenue growth and 70% felt they were more agile and streamlined than non family businesses.
However, despite having a substantial turnover and good profits, some smaller businesses (more often than not those with a sub £20m turnover) in the UK are facing an existential crisis. The next generation either is not there or not interested in continuing the family business. They may want to pursue different careers or have other objectives. This often makes a continuation of the family owned company impossible and presents the board with some difficulty and far reaching decisions to make.
There is the option of bringing in an external management team while the family retain their shares, but this is not always and ideal solution. It requires at least a performance related incentive scheme if they are to succeed. Generally, this will involve share options, which when exercised leads to transition from it being a family company. For the existing shareholders however, it can mean that they have their money locked in the company but with limited control over the new management.
More likely the company will be sold, realising capital for the shareholders. If the business is successful, shows year on year growth, has a competent workforce and market share with potential then it is saleable. The buyer may be a competitor or someone wishing to enter that sector but unwilling to start a new venture, or a management buyout (MBO). If the company’s turnover and market share are dwindling, there has been no investment in technology or talent and if management team has performed below par it will be difficult to find a buyer and liquidation may be the only remaining option.
Less than a quarter of family businesses have an exit plan. This is something that needs to be considered and put into effect after discussions with lawyers and accountants as a matter of priority.
For the shrewd investor remarkable value can be obtained by acquiring a company where succession is an issue and an MBO is not an option.
The business can be sold either by disposing of the shares or the company disposing of its assets and that choice will usually be determined by the market, although the tax considerations will often be an important factor.
An MBO is an option where an outright sale is not easily achievable and there is a sound management team in place but for the seller it has some disadvantages and will seldom achieve the same price as the open market. The management team will not want to pay more than they have to and will need access to finance which will only be available if there is regular, positive cash flow, non-demanding capital expenditure and a modest risk profile.
There are significant tax and legal differences between the sale of a company’s assets or its shares, and it is important that those involved with making these business decisions use professional advisors who are experienced in this field. For the seller, the opportunity to avail themselves of Entrepreneurs’ Relief with a headline tax rate of 10% will be attractive.
Banks will advise on and assist with the sale of larger companies but few are interested in deals below £100m. A business with a turnover of between £2m and £50m will generally be better served by a company specialising in corporate sales, of which there are many, with a specialised team who will advise on strategic exit preparation, assemble and present financial details (not a prospectus), research the market and competitors and seek a potential purchaser. This may include some debt restructuring and provide other corporate finance advice where necessary. If successful they will assist with negotiations. If not, they will advise on other available options including an MBO and an asset sale. Fees are charged by retainer, on an interim basis and as a percentage of the sale proceeds. There is no guarantee of success and those companies in poor shape must be aware of the position before embarking on this route.
Many estate agents have also moved into this area with specialised divisions, particularly where the company is property based, such as care homes, hotels restaurants, clubs and independent pharmacies.
The valuation of the shares in a company will be based on its balance sheet which of course is be affected by the strength of the brand, its IP rights, current and future perceived financial performance, customer base, experience and skills of management team, supply chain strengths and any synergies with the buyer. An MBO will typically reflect some but not all of these and but the seller will not participate in any management or synergy premium which is likely to figure much more in an open market sale.
With larger companies that have invested in technology, have an excellent management team and workforce, a sizable market share with commensurate turnover and profit there is the option of an initial public offering (IPO). Shares are issued which can be traded on the stock market. Whilst it is an expensive and complex process for the larger company, it can create a very lucrative position for the sellers.
The disposal of professional practices is a different matter as they are often unincorporated and more often than not trade as partnerships or LLPs. As such, they are entirely different in terms of valuation and disposal and are excluded from the businesses discussed in this article.
For more information on this topic or on any other company commercial issues please contact:
Tel: 020 7408 8888