There comes a time for family businesses to make a transition. In some cases, the business is passed down to the family's next generation. But when that's not an option, there are other transitions that can be made.
Family business owners, especially in the Philadelphia market, prefer to have the family stay in the business for legacy and other reasons. But the reality, said Barley Snyder Partner Paul Mattaini during last year's Philadelphia Smart Business Dealmakers Conference, there aren't that many second, third, fourth or fifth generation businesses, and there must be a reason.
"One of the methodologies, obviously, is to pass down, through gifting or through a will, interest in the business," Mattaini says. "One of the issues that comes up is, are there capable people within the family or do you have to bring in a non-family member or CEO, which I've had clients certainly that have been successful doing that. But that's a little bit of a tough road sometimes; they have to probably prove themselves more than he or she would have to do otherwise."
And there are many questions to answer as a family prepares for a transition. For example, when it comes to governance, will a family business have an outside board? Is the senior generation going to stay involved for a while at the board level? Are they going to do voting and nonvoting stock, which is a typical first step? And even if they'd like to do that, is there enough liquidity for the senior generation if they just give the company to the next generation? There's also the question of how to handle a scenario in which one of the family members aren't interested in working in the family business.
Other options for family business owners would be to sell the business to the next generation rather than giving it to them. Or the owners could transition out through an ESOP, a method that's gaining in popularity.
"There are some advantages and disadvantages," he says. "Some of the disadvantages would be the lifetime valuation is not as high for an ESOP, and there's a lot of regulations. The advantage is that if you're really into employee friendly ownership, that's great. There are some tax advantages. There are situations where there might not be the same value to sell to a third party — you might have customer concentration, or whatever else it is. So, that might be a good exit mechanism, if you will."
Family business owners could also sell to strategic or financial buyers that strategic, each of which, for some, have their drawbacks.
"A lot of times our clients don't want to talk to the strategics for competition and confidentiality reasons," Mattaini says. "And then there's financial buyers. And that's a whole other set of clients that don't really understand private equity. They have this vision of what private equity is like, but the reality is actually there's probably more opportunities for their management team, and more opportunities for rolling over some ownership where they can continue to participate in the growth of the company."
The sale of a family business is often a once-in-a-lifetime event, or might happen once every two generations. Unfortunately, a number of family businesses aren't clear on what their next move will be.
"Most of our clients, their succession plan is basically to wait forever. And their identity is tied up in the in the business, so that makes it hard to walk away. It's very hard to get a client to sign their will, much less figuring out what they want to do with the business. So, as an adviser, I think it needs to be part of the checklist for them and for the people that are lenders to the company, the accounts the attorney."