A Generation of Hard Work Deserves a Lifetime of Benefits – Finding the Right Future for Your Family Business is Easier Than You Think

7/20/2017

By Will Brame

Baby Boomers are reaching retirement age and what that means for many small business owners and private equity firms in the lower-middle market

Family-owned businesses are a critical element to the backbone of the U.S. economy, with estimates that family-owned or family-controlled organizations account for as high as 80 to 90 percent of businesses within the U.S. For the broader economy, these businesses account for 64 percent of U.S. gross domestic product and are estimated to employ nearly half of the U.S. workforce.

Wal-Mart (Walton family), Berkshire Hathaway (Buffett family), and Ford Motor (Ford family) are just a few of the most well-known family-owned or controlled firms in the United States. However, most family-owned businesses, as thought of in the traditional sense, are smaller organizations that most in the larger public have never heard of or interacted with. Oftentimes, these firms are suppliers or vendors of a product or service to larger companies, such as, for example, supplying widgets into a larger machine that is ultimately produced by well-known brand names like General Electric, 3M, or John Deere. Though these small businesses may seem miniscule when compared to “blue chip” corporations, a vast majority of these organizations have been in existence for at least two or three generations, consistently generate positive cash flow from operations, and continue to remain innovative, defensive and adaptable to sustain impressive financials despite what has become an ever-evolving corporate landscape in the 21st century.

The baby boomer generation, which has been identified as those born in the post WWII period between 1946-1964, account for many of the individuals leading family-owned businesses who are now approaching retirement age and are ready to transition these organizations onto the next generation. The problem today is that companies that would have been passed on to the younger family members are struggling to find willing, capable or otherwise available “next generation owners” inside of the family, especially as many high-performing millennials are lured by the attractiveness of capturing a quick outsized return in the technology or financial services sectors. An analysis of the graduating class of 2016 at Harvard Business School reveals that 28 percent of students pursued careers in financial services, 25 percent in consulting, and 19 percent in technology.

In the 2017 U.S. Family Business Survey by PricewaterhouseCoopers (PwC), a biennial report dating back to 2002 that presents the findings from a survey of 160 key decision-makers at U.S. companies across a range of industries, we learn that fewer family members today plan to pass a business on to the next generation. This is particularly noticeable in those firms that foresee an ownership change in the next five years, where only 52 percent of owners plan to keep family-owned businesses in the family versus 74 percent in the previous survey published in 2015. This trend remains consistent as these decisions are contemplated beyond a five-year timeline and when family owners are debating passing on ownership as well as management. These results echo a gap of willing owners in the family and the potential need for professional nonfamily managers to support operations.

In addition to the lack of next generation owners in the family, the increased complexities of navigating a more global market, identifying new acquisition targets and business lines, and staying in front of potentially disruptive technology and innovation present fierce uphill battles to individual or family-controlled businesses. Many of these tasks require an experienced institutional partner with access to substantial growth capital, which is an avenue many family-owned businesses have never explored. As PWC further notes, 76 percent of respondents looking to grow significantly said they would be relying on their own capital citing challenges in securing financing and the expensive nature of these transactions.

Hesitations to seek an outside capital partner are often centered around a concern that these parties will be disruptive to an organizational culture and ecosystem built over the years, or that external individuals lack a true understanding of the business and the experience necessary to accelerate growth. Other concerns focus on the expensive nature of such transactions, both from a financial and control perspective. Though these apprehensions are understandable, they can be resolved through mutually-advantageous structures, such as offering capital partners minority instead of majority investments or by keeping family management in place while offering professional partners seats on the board of directors.

The anticipated future growth in business owners looking for strategic partners presents an attractive opportunity for private equity firms that focus on the lower-middle market segment of the industry, which is typically defined as a focus on companies with $10 million in annual EBITDA (a common financial valuation metric meaning “earnings before interest, taxes, depreciation, and amortization”) or below. Not only will there be a growing number of opportunities in this segment, such opportunities will also be oft-overlooked as many of the larger private equity firms avoid this part of the market as they cannot obtain the returns necessary to satisfy their general and limited partners given the size of capital they manage. Surprisingly, this is often where some of the more favorable opportunities exist, as many smaller businesses today are 1) those most in need of access to growth capital 2) have failed to diversify from selling existing goods and services despite having a competitive advantage and the infrastructure in place to do so, and 3) can significantly benefit from outside professionals assessing new, future market opportunities while helping to avoid disruption that may be looming.

Due to the complexities presented by today’s business culture and landscape, business owners who are among this retiring baby boomer generation and anticipate a future for their family legacy should more openly consider strategic partnerships, both to leverage “growth” capital and outright sales, with professional capital partners. These partnerships can open doors to growth avenues never considered by smaller family businesses and such relationships can be structured in ways that benefit all stakeholders at the table. Ultimately, although certain hesitations will always exist, the global business landscape is rapidly evolving and potential sellers must remain competitive to continue a family legacy that has been built over the years. These capital partners will help fill a gap produced by the lack of optimal management successors, while providing the financing required to compete on a global level and the guidance necessary to navigate innovation and looming technological disruption.

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