Family Businesses Face Market Pressures to Diversify or Exit

Headlines all point to a record-setting year for mergers and acquisitions (M&A). Consider the following:

• The Wall Street Journal (citing data from Dealogic) reported the number of deals closed in the first eight months of the year are at the highest levels since 1995, and are on pace to break the full-year record set in 1995.

• Bloomberg Law estimates that if the current pace of private equity-backed M&A holds through year end, 2021 deal volume (in dollars) will surpass 2020 by 34 percent and 2019 by 29 percent.

Certainly, proposed changes to the tax laws (most notably the capital gains tax) are creating a sense of urgency (if not panic) to sell businesses by year end. Adding fuel to the M&A fire are historically low interest rates that are expected to begin to rise in 2022.

For family-owned businesses, there may be other motivations for selling your business.

While its impact pales in comparison to the devastating loss of lives and livelihoods, the pandemic has stressed ownership, management, and employees in ways no one could have ever imagined. For some companies, difficult but necessary actions taken at the beginning of the pandemic may have resulted in (unanticipated) record results as consumer spending came roaring back. If that’s the case, then this could be the best time to lock in a high valuation and sell your company at a premium.

What if you are the owner of a multigenerational family business where there is no more “family” in the “business?” There may be concerns about having family wealth locked up in the business, or a desire to accelerate philanthropic endeavors by taking some (if not all) of the family money off the table.

Perhaps your business is highly concentrated in one sector or industry. You may want to diversify that risk by selling some assets and reinvesting those proceeds into a portfolio of businesses with broader industry or market exposure.

Whatever the reason (or combinations thereof), there are several paths forward depending on your intentions pre- and post-sale.  

If your desire is to transition ownership while retaining company management and culture, then exploring an employee stock ownership plan (ESOP) is one option to consider. The tangible benefit to family ownership in an ESOP transaction is the potential (with proper tax planning) of lower taxes on proceeds. There are tax advantages that also accrue to the company on a going-forward basis. Last but certainly not least, there is the satisfaction that comes with giving employees opportunities to invest in the company, enabling them to benefit from future company growth. ESOPs have long been popular vehicles for family-owned businesses to sell either some or all of their company back to employees. In a partial ESOP, the family can also remain in control of the business while taking some money off the table.

In fact, the events of the past year and the race for liquidity have caused Mary Josephs, founder and CEO of Verit Advisors, to declare that 2021 may herald in “The Decade of the ESOP” given some of the advantages an ESOP can provide versus other options for sale.

That said, ESOPs come with legal and compliance complexities related to administration and oversight—regardless of whether you are a partial or 100 percent ESOP. Understanding the regulations governing Employee Retirement Income Security Act (ERISA)-related plans is a critical first step in exploring this option.

If your desire is to maximize sale price and exit the business completely, then sale to a third party may be the best option. While you may have received unsolicited offers for your business in the past, resist reaching back out to those parties until you’ve retained an advisor. Whether it is someone in a boutique, industry-specific shop or a global investment banking firm, the right advisor (with a sliding fee structure based on final sale price) will ensure that there is a rigorous process in place to solicit and assess competing offers. It will also signal to potential buyers that you are serious about a transaction. Make sure you have relevant tax, estate planning, and legal advisors at the table as well.

What are the caveats of a sale process? First, understand that it will be all-consuming for management and potentially disruptive to the business. Leaks (and there will be leaks) will foster fear among employees and create a buzz in the marketplace (which competitors may use to their advantage). “Busted auctions” (where there is no bidder or only one) can also occur, so making sure there is a “Plan B” in place is essential in the event that there is no sale.

Perhaps most difficult for many family businesses is the loss of control over the business and its legacy. After all, companies buy a business to run a business. Changes will be made. New owners can decide to enter new or exit old markets, consolidate facilities, or layoff long-tenured employees.

On a more positive note, a successful sale may result in proceeds that can be used to invest in a portfolio of new businesses. If the proceeds are large enough, creating a family office with the requisite internal and external talent may be a great opportunity to keep the family working together to identify the next horizon of growth for future generations. Those new businesses may even attract younger family members into the business—family members who previously had no interest in the “legacy” business. 

There may never be a better time to sell your business. Make sure that whatever option you choose aligns with your intentions both pre- and post-sale.