“Shut up or I am out of here, you liar!”
This was the first thing I heard as I arrived a few minutes late in our conference room the other day. The man who had just yelled this ultimatum was pointing his finger towards a dapper gentleman in his fifties who sank in his chair, mumbling something about how his honour had been unfairly attacked. Some start to a meeting, I thought -especially since everybody else in the room seemed strangely unfazed by it all.
What I had walked into was a meeting with a family that owned a medium-sized industrial company that we were interested in buying. It was obviously not going to be a smooth session. There were ten people around the room: cousins, uncles, brothers and sisters. They all belonged to the same family. They were all shareholders of the same company and all of them were angry, albeit for different reasons. Needless to say that I was curious as to what was going on here.
Twenty minutes into the meeting I had managed to piece things together. One cousin had been running the company for ten years and was now looking to acquire it outright. During his tenure, according to some of his relatives, he had been paying himself a very handsome salary while grooming his allegedly “incompetent” son to take over the reigns. Now he was offering to buy out their share at what even to me seemed an obscene discount. However, for reasons that were not explained, an uncle with a large chunk of equity in the business who had travelled to the meeting from his lakeside villa in Switzerland, seemed to support his cousin's plan.
We spent an hour talking about how we could structure an acquisition, the benefits of using leverage in the deal and the optimal timing of a break-up so the company could focus on its best divisions. I don't think anybody really listened. Needless to say, nothing ever came out of the meeting.
Buying family businesses isn't easy. Private placement memoranda of mid market buyout funds invariably state that family-owned companies are as legitimate targets as corporate disposals. But what may be true for smaller leveraged acquisitions of corporate assets doesn't necessarily hold for mid market transactions involving family-owned entities. There are several reasons for this.
1. A typical family business, as my meeting with the angry family demonstrated, is often run by one member of the family while several relatives are passive shareholders. When the time comes to facilitate a management buyout, the manager participating in the transaction has an incentive to minimise the price paid for the company so as to maximise his personal profit sharing with the equity sponsor upon exit, while the passive shareholders will want to drive up the price to maximise proceeds from the sale of the business and hence their liquid net worth. This can make negotiation dynamics difficult, to say the least.
2. Family businesses, especially those still managed by a first generation entrepreneur, tend to have strong CEOs. Some of these managers tend to view buyout funds as mere money providers, not as fully-fledged partners. This makes it very difficult for a fund to implement even simple corporate governance rules and to establish a board-level dialogue where putting an issue onto the agenda does not automatically lead to a head-butting competition. (Managers of corporate spin-offs on the other hand are used to having to report to directors, to establish regular budgets and to deal with other constituencies, which arguably makes them better equipped to participate in a buyout.)
3. Family businesses tend to employ family members, and not always for the right reasons. Be it because the tradition has always been to work in the family business, or because a family member can't find a job elsewhere or hasn't got through college, there are likely to be some relatives on the organisation chart who are not necessarily best suited for the task they are responsible for. This usually makes the best employees flee to more meritocratic ground, which doesn't leave financial investors looking to create shareholder value much to work with.
4. Unlike corporate spin-offs, which tend to be focused businesses whose operational performance and cash metrics are neglected by parent companies that are too busy concentrating on larger issues, family businesses are often pursuing a hodgepodge of activities that are nickel-and-dimed so as to maximise dividends to shareholders. This means that margin improvements or general and administrative expenses deflation are hard to achieve, thus making IRRs solely dependent on financial leverage and sales growth.
5. Finally, a certain amount of distrust on the part of family owners towards private equity financiers can make the negotiations of a buyout difficult. A family business shareholder once told me: “You just suck out all the value created by those who do the real work”. It is tough to fight the lazy-and-greedy-vulture cliché – even more so when we explain that we are looking to triple our money over five years. Family owners who have invested decades of sweat and tears and lived with limited liquidity are prone to feeling queasy about what from their point of view may well seem “exorbitant” expectations on the part of a financial sponsor.
Another, more intuitive way of describing the difficulties that private equity investors can run into when dealing with family businesses is that these businesses often resemble the families who own them. Some are successful, peaceful and ambitious, while others are a mess, entangled in self-created difficulties. Spotting the gems and shunning the headaches is the name of the game.
That isn't easy, partly because there don't seem to be many gems around, as a look at some recent statistics indicates: in France in 2002 for example, according to data compiled by Initiative Europe, the private equity research house, there was just one leveraged buyout of a family-owned company with an enterprise value in excess of €100m, out of a total of 19 transactions in this category that year.
A similar picture presents itself in Germany: buyout funds have long set their sights on the supposedly fabulous potential of the Mittelstand, the country's mid-cap market segment where thousands of large family businesses have been thriving since the end of the Second World War. Many of these funds have been disappointed by the lack of opportunities that so far have materialised: Initiative Europe reports that only five of the 19 buyouts with a value in excess of €100m completed in 2001 and 2002 were family businesses.
The ratio is even worse in some countries like Sweden, Italy or Switzerland where Initiative Europe reports that no family businesses with a value greater than €100m were sold to buyout funds in 2002.
Many families never overcome the obstacles that made them crave a sale in the first place
To be fair, family businesses often end up being acquired by larger corporates before appearing on the radar screens of equity sponsors, which explains part of the shortage. And some of them eventually do make it to the LBO market once these trade buyers undertake large-scale restructuring. Terreal, the French clay roofing tiles division of Saint Gobain, is the perfect example of such a transaction: its foundation was built around three family businesses in the 1980s and built up into a sizable player with sales in excess of €300m. Earlier this year it was put on the market and acquired by The Carlyle Group.
But this kind of outcome is certainly not a foregone conclusion even where a change of ownership seems a good idea to those who share in the ownership of a family business. Many never overcome the hindrances that prompted some of their owners to consider – or indeed crave – their sale in the first place.
A few weeks after my meeting with the warring family, I received a call from one of the cousins who had remained silent during the squabble in our conference room. He asked if I wanted to buy his shares, which represented a minority stake in the business. I explained, once again, that we only get involved in amicable transactions where we become controlling shareholders. He sighed, shared with me his conviction that one should never do business with one's own family and hung up before I could wish him good luck. The last I heard, the situation had not been resolved. I can't say I'm surprised.
Marc Bataillon is a partner at LBO France, a Paris-based private equity firm.