We’re working with one of our buy-side clients and have identified a company they’re interested in. We’ve talked to the owner and he’s considering, but he’s just not sure. The sticking point? He has two sons and he might want to pass the business on to them.
I’ve been in this industry for two decades and I can tell you a lot of owners start out in that idealistic place. They dream about passing the business on to their kids or management team, but as retirement draws closer, the reality of those arrangements starts to hit.
Ironically, most people don’t even talk to their kids about taking over the business, until they’re ready to sell. At that point, many find out their kids don’t even want the company. After seeing their parents deal with the time demands and pressures of ownership, many kids opt for a simpler way of life.
Still other parents come to the realization that their kids aren’t really a good fit for ownership. Perhaps the business just doesn’t give them energy or spark a passion. After working in the family business their whole life, some “kids” are ready to do something different when their parents sell. Or maybe the business has grown to the point where long-term sustainability really requires a new set of skills.
Passion and aptitude aside, can your kids even afford to buy the business? Are they willing to put a personal guarantee on their house to get bank financing? Is their spouse willing?
In cases where the kids or management team don’t have the resources to get a loan, the owner can fund the transition with extended seller financing. The business draws on cash flow for seven to 10 years to buy out the owner.
If that’s your intended path, consider the strain on your family and the business. What if something goes wrong and the kids have to default on that note? I’ve seen brothers cut each other off over a family business conflict. I’ve seen marriages rocked by the financial strain and risk. I’ve seen families who don’t get together for the holidays anymore.
Or, let’s say everything goes okay. You’ve still put a significant capital restraint on the company. They’ll be treading water for almost a decade while competitors are gathering market share.
Is there a way to have your cake and eat it too? A way to pass ownership to your kids or management team, without all the risk? Sale to a private equity firm could allow you to get most of your cash at close while still transitioning partial ownership to your kids.
Private equity firms often look for opportunities to keep experienced management in place. They provide a fresh influx of cash plus savvy business leadership to usher the business into the next stage of growth.
And with the large number of buyers in the marketplace right now, these firms are looking at creative ways to stand out and get deals one. One way of doing that is to buy 60 to 80 percent of the company while allowing the owner’s kids or management team take on an equity stake and build their financial future.
As a seller, you provide your kids or managers the prestige and personal satisfaction of becoming a business owner, while setting them up for success with mentors and a proven growth team. Meanwhile, you eliminate all or most of the financial strain of funding a family business transition.
The good news for many folks in this scenario is that private equity firms are holding investments longer—seven, 10, even 15 years. That’s enough time so that your kids can work with one long-term business partner until they too are ready to sell and retire.
At that point, they benefit from all the growth the private equity firm has helped bring about. Years from now that minority ownership share could potentially net them just as much as your full sale. It’s a way to reduce your family’s risk while giving your kids or management team an opportunity to grow their own financial futures.
As I see it, it’s a win-win all around, particularly at the holidays. Pass the potatoes and let’s talk shop, tension free.