By Wayne Rivers

We were recently visiting with an advisor who was detailing the time, effort, and toil which had gone into the planning process for selling a family company from the senior generation to the junior one. The company in question was a significant petroleum distributor and convenience store operator, and both generations were excited about the win-win nature of the deal. However, the advisor saw a fly in the ointment: he was worried about the amount of time and focus spent on the first part of the transaction, that is, all the things leading up to the sale. He saw a severe lack of attention devoted to the aftermath of the deal. The second part of the deal was contingent (due to considerable seller financing) on the second generation family business owners running the company successfully and profitably over the next fifteen years in order for the transition to become a true win-win. He likened it to a shortstop that got in position to make a play, fielded the ball cleanly, but then forgot to throw to first base. The play wasn’t over until all aspects had been completed flawlessly.

We shared the concern of the family business advisor. Most family business owners and their advisors focus all of their time and attention on the front half of the deal and leave the successful operation of the company following the transaction to chance. They assume that because Mom and Dad ran the business successfully for thirty years that the children will simply pick up where they left off, and the business will continue to grow and prosper. That’s a dangerous assumption to make.

There are only four methods for disposing of a family company:
1. Close the doors and shut it down.
2. Sell the business to outsiders.
3. Sell the business to insiders.
4. Keep the company in the family and successors inherit the business.

Since most family business owners recognize the economic folly of shutting the doors and walking away from the business, that’s usually not an attractive option. In our experience, about 95% of the potential sales to outsiders fall through during the due diligence process for one reason or another. Since we can usually eliminate the first two options, that leaves the second two - selling to insiders or inheritance - as the most viable options for transferring a family enterprise. The default disposition method is the fourth one which necessitates sound estate planning and extreme patience on the part of the subsequent generation(s). If those two conditions are met, the business can stay in the family via gifts and inheritance. The balance of this article will discuss how to sell a closely held business to insiders. Running a business is more challenging today than it ever has been before. The pace of change in everything from computer and information technology to medical insurance to motivating employees is evolving at a continually faster rate. Since most transactions involving sales to insiders involve some form of owner financing or indemnification of third party debt, the senior generation is dependent on the junior generation to sustain the vitality of the enterprise.

In Figure One, it’s easy to visualize what takes place in the pre-transaction phase of this family business sale. The senior generation and the family business advisors undertake analysis, due diligence, valuation, and personal and corporate financial planning in order to assess the viability of the sale. There are letters of intent, confidentiality agreements, and contracts to read, write, negotiate, and sometimes battle over. The pre-transaction planning could take six to eighteen months and could require tens of thousands of dollars - not to mention the time invested - by the family business owners and their staff.

What FBOs and their advisors ignore in this sequential planning format is all of the things that have to get done following the transition in order to make the deal viable over the long run. Those things include strategic planning, reorganization of management roles and responsibilities, delivery of the company’s goods or services, and healthy, balanced operations in the family business. Someone in the organization has to address the vitality of marketing, sales, IT, finance, administration, and HR. Perhaps more importantly in this new dawn of corporate owners and managers, the issues of effective communication and teamwork come into play. How are the buyers going to get along with each other in their roles as owners now that the parents and business leaders aren’t around anymore? They formerly had one final decision maker who had clear parental and moral authority; now they have three equals who have to make decisions collectively. How are they going to come to conclusions and make effective business decisions while simultaneously preserving sibling harmony? The inescapable point is this: in spite of the intense due diligence and the tens of thousands of dollars expended before the consummation of the transaction, the deal is contingent on what happens after the papers are signed. Simply put, if there are no future profits, neither generation prospers, and there’s no winner in the transaction at all.

A better way to structure an intergenerational sale in a family enterprise is to engage in a process called parallel planning. In Figure Two, all of the analysis and due diligence items which are present in Figure One still take place. All of the planning, operations, and communications items are still present as well. The main difference between Figure One and Figure Two is, instead of these processes taking place sequentially, they take place simultaneously in a parallel mode. In other words, the due diligence in Figure One isn’t truly diligent because it doesn’t contemplate and explore the post-transaction items without a substantial time and attention disconnect. True due diligence in a family business transaction should undertake both pre-transaction and post-transaction planning and design simultaneously in order to give the family business the greatest probability of success, future profits, and true intergenerational win-win. As Bobby Knight said: “the will to win is nothing without the will to prepare to win.” Parallel planning is the process that can successfully marry both the will to win and the necessary preparations and due diligence in order to assure victory. ■  

Wayne Rivers is the president of The Family Business Institute, Inc. FBI’s mission is to deliver interpersonal, operational and financial solutions to help family and closely-held businesses achieve breakthrough success.
Vol. 10, Issue 2