Melanie Stern is Section Editor of Families in Business magazine.
Big business or big bucks is the choice presented to a family business through mergers and acquisitions, depending on how it views its future. Melanie Stern explains how the challenges faced by this sector proves that size has never mattered more in either case
Mergers and acquisitions (M&A) have typically provided big, progressive companies with a chance to swallow the competition or become the biggest player in their market without the elbow grease usually required. They can also be a way to realise one's hard earned but immobilised wealth, and enjoy it. Low company valuations as a result of protracted M&A and IPO downturns have recently been attracting bargain hunters back to the market, with the field of family business looking busy already – hotel chain Marriott was one of a handful of those interested in the acquisition of hospitality group Six Continents in early Spring, while UK supermarket Safeway received interest from family businesses Wal-Mart, and UK supermarkets Morrisons and Sainsbury's.
Buy and build
Acquisitions usually apply to mid-sized businesses that have reached critical mass – they're successful, steady, with a healthy client base and sound financials. The owner-manager of such a business may not see growth as important as existence, and therefore may not have a realistic view of what competition they face, but thus lies the potential; a large, rich, growth-hungry corporate focused on ever-improving quarterly performance share performance will view this acquisition as the opportunity to jump a few places up the competition league tables, with room for further improvement. "Public companies are very bad at starting up new businesses and growing them, but they are very good at buying up and taking over successful businesses and growing those," says Howard Leigh, a director at UK private and family business sell-side acquisition advisory Cavendish. "They don't have the resources to invest in completely green fields."
The family business may itself seek to acquire for reasons of immediate growth, to eliminate the competition, attract bigger customers or with a view to becoming an acquisition target – known as a 'buy and build' strategy. "As a family business, you might find your size is important in your relationship with customers. For example, if you work with very large clients, they would be happier dealing with a large firm," says John Hawkey, an advisor to private and closely held businesses in exit strategy planning. "As a longer term strategy, a reason for an acquisition might be because they wish to expand with a view to going public, to shift the emphasis on the industry sector they are in, which can have an influence on how they are viewed by the market and investors."
The UK family business could want to become an acquisition target now that capital gains tax in the UK has been reduced 10%, making it more tax effective to start up and sell a business. "Private companies reach a point where they decide it is perfect for them to sell – maybe retirement, maybe the business has reached the end of a cycle," according to Leigh. "The family may have considerable assets tied up in property, equities and maybe some government bonds, but the single largest assets are the share certificates to their own business. If you sit back and look at the family portfolio, it makes sense to realise that one asset that is highly illiquid, highly risky but very valuable. The trick, which family businesses are very good at, is recognising when their business is in that part of the life cycle when it is right to sell; in my experience, you can take advice on that, but most entrepreneurs just have a feeling."
Crucial for all family businesses to tackle first in any M&A approach is the grooming process. Family businesses may not be as professionalised as their non-family counterparts, and this can determine the value of one's business based on how much it will cost a buyer to improve it after purchase. Companies like Cavendish will look at a business and highlight what areas need to be groomed in order to create the optimal acquisition package.
Aside from grooming the brand, financial position and market positioning, one of the most important grooming requirements family businesses face in a sale preparation, according to Leigh, is in second-tier management. "Some family businesses are in a bit of a mess in these areas when they come to us – they don't have non-executive directors or strong auditors, and have not bothered with statutory matters." Hawkey also thinks this is key, and even more so with technical or niche family businesses. "In any acquisition you face the problem of managing a new entity. If the acquisition is to be run purely on its own with the existing management in place and a new managing director drafted in to replace the owner, then the important part is actual retention of key management and other staff. An acquisition should be based as much on that as on financial issues," Hawkey believes. "If your acquisition is made in the same industry and your staff already have the required expertise this is then less of a problem. If the acquired company is in a technical or scientific sector a lot of its value will be in the technical and intellectual skills of its management, and thus the issue of retaining them becomes vital."
Mergers – a happy marriage?
A company may look to merge with another for similar reasons to an acquisition – to eliminate the competition, but also to take advantage of it. The process, however, comes with its own set of operational issues; if two entities, with their own rules, are to become a single company with one set of rules, then who is the leader – and whose rules prevail?
Hawkey believes these issues are so potentially problematic that mergers in the private and family business sector often fail, and are sometimes simply acquisitions in disguise; some mergers start our with a 60-40 share ownership, for example, but in the longer term the acquiring firm may plan to buy up the interests and shares of the other company over a period of time – somewhat crafty. "Some acquisitions are dressed up as mergers, but they usually end up with one company being dominant, either in shareholding or in management. In a merger you face a cultural management issue, as businesses do things differently to one another, and you've got to reconcile those differences. You've got to figure out who is the boss of the merged entity and you usually find that the management of one of the entities gets fed up or leaves in a relatively short time," Hawkey explains. "This shows the difficulty of bedding down to two different management cultures."
Financial impetus for German families
In Germany, family businesses face another issue that some say could result in increased M&A activity in the sector. Under the updated Basel Capital Accord to be rolled out across the international banking sector, banks will have to calculate their margin according to the individual financial risks they take. German family businesses are one of the top users of long-term bank loans in Europe and this affects their credit standing, making them a risk; so, as a result of the Accord, banks will have to increase their margin if they want to lend to this credit-challenged sector. As a result, family companies may choose to merge or acquire to become bigger and obtain a better credit rating, or be able to explore other avenues of finance – either that, or they may just sell up. "This will really influence family companies in the next year, because they have the highest rate of long-term bank loans and the relationship of those loans to their equity is much higher than other European countries," according to Dr Martin Sorg, partner at leading German family business law firm and M&A advisory Binz & Partner. "Germany has more of a problem with this than elsewhere because of the specific structure of family-owned companies there and their use of long-term bank loans, which for many companies will become much more expensive and will be more difficult to obtain."
Aside from capital adequacy pressures, Sorg also notes that there is a large turnover of family business leaders expected soon in Germany, as many of these entities were founded after World War II. With the founders of these companies now in retiring age, and with successors seemingly not forthcoming, Sorg thinks many families may sell their businesses through merger and acquisition activity.
Learning to let go
However the family decides to solve these challenges, it seems hard to imagine the owner-manager selling their cherished business with a smile on their face – and similarly, do the rest of the family simply accept it without a problem? "Invariably in family businesses, there is shareholder conflict," Leigh explains. "We once sold a family business with 160 shareholders, all with different objectives, and their only common interest was their intense dislike of each other. Even when there are just two shareholders, there can be a lot of tension."
Leigh adds: "The PLC is buying and selling businesses all day long, but for the family it's a one-off move – the golden goose; it's got to be absolutely right as it's the most important business decision they can make. It is often very difficult and emotional and we've frequently had tears at the completion meeting. But at the end of the day, it isn't a hobby. They are in this for the business and that's the motivating factor."