What happens if a family-owned business is in financial distress? When insolvency threatens, can the family legacy be preserved and their interests protected? Business rescue practitioners face a complex challenge when family emotions come into play during the rescue process. From small ‘mom-and-pop’ firms to family-controlled empires like Walmart, Samsung and Porsche, practitioners need to be sensitive to the family dynamics and the value attached to their legacy which can extend over generations.
In terms of the role family businesses play in a country’s economy, their contribution and status is often undervalued. They are mostly privately owned and the financial information does not get distributed to anyone outside the family. As a result, their contribution cannot always be accurately measured. However, in the US, analysts have suggested that a third of all companies with a turnover more than $1billion per annum are family owned.
The ownership control of most family businesses is spread among Trusts, holding companies or personal equity holdings. Even though some are large multinational conglomerates, shareholding and ownership are mostly held by private persons and not companies.
These businesses are usually founded by people with entrepreneurial flair and savvy business aptitude. Multiple family members often become involved in the business either at the start or as it develops into a larger organisation. With the passage of time, when the original, or current, owners start to age, younger generations are more often than not, recruited to join the ranks.
2. Family businesses face unique challenges
The family business is usually built on the values of the founder(s). These values, which come from both their emotions and the objectives they have as goals for the company, are ingrained into the company culture. Family dynamics play an integral part in both the development of the culture and success of the enterprise. If these dynamics are not managed adequately, these can unsettle the performance and profitability of the business.
The decision-making process moves from the boardroom to family dinners and activities. Other stakeholders, who can also be family members, are not always consulted. They find out about changes and decisions after the fact.
Nepotism, and/or favouritism, can adversely affect a company in two ways; unearned promotion and cover-ups.
When the correct procedures have not been followed, and family members are appointed to positions above their pay grade and capabilities, this leads to unhappiness and demotivation among employees who are not family members. Especially if they have more experience and expertise than the recent appointee.
The family member managing the business often covers up mistakes made by siblings or children.
The success of the business is not always calculated in financial terms, but rather as value-added wealth-creation mechanisms, social capital and family unity.
“At PwC, we know that the most successful family firms are those in which there is a good balance between professional management, responsible business ownership and a healthy family dynamic.” PwC Family Business Service website.
Unfortunately, more often than not, good governance is not followed and decisions are made at the whim of the owner or major shareholder.
3. Generational Transition
The younger generation are expected to join the business – the founders or older generation want it to remain in the family. All too often we have witnessed family businesses failing after the younger generation take over control. They don’t have the vision of the founder and want to follow their own dreams.
However, having said that, there are times when the younger generation has the courage to restructure the organisation and completely turn it upside down – for the better. They view the management and operating environment with fresh eyes and take the necessary decisions to return the company to profitability. Overhead costs are cut, good governance and strict control mechanisms, including new processes, are introduced. They instil contract management, rather than management of the projects.
At this point, the company is in business rescue. If it fails, a number of families would be negatively affected. The first-generation directors have signed away their personal assets. Emotions run high on many occasions, especially when some of the harsher decisions had to be taken.
The business rescue process is independent of the management of the business. This helps as it provides a more balanced approach to the decisions required by the company’s management.
4. Selling the Family Business
Reasons for sale
The decision to sell the family business is not a simple one; the emotional attachment to building a legacy for future generations is strong, often the driving force behind the company in the first place. The positive side of the decision is that the sale should produce a sizable realisation of value and cash. The family as a whole, or as individuals, can move on with their lives and pursue other lucrative opportunities.
There are four main reasons family businesses are sold.
- The multi-generational succession plan cannot be implemented because younger generations want to pursue other career paths outside of the family business;
- The owners and stakeholders are considering retiring or reducing their work load;
- The family wants to capitalise on the wealth created in the business;
- The business has developed to a stage where a large amount of capital is required to continue on the growth path and the owners are reluctant to risk their savings and assets.
Terms and conditions
It is important to bear in mind the following factors when selling a family business:
Careful consideration must be given by all shareholders to the terms and conditions of the sale agreement.
Try not to give warrantees and guarantees about future performance of the business, especially if the new owners are going to manage it in the future.
Investors may present a bullying mentality, because they have the money and the power to make demands on the sellers, and not want to pay the perceived value of the entity. Valuing an unlisted company is not a simple task. Various methodologies are applied in these calculations. The methods are:
- Net Asset Value – Assets minus liabilities. This is the floor level of the price. A premium must be added for brand recognition and trading performance over the years.
- Discounted Cash Flow (DCF) – Net present value of future cash flows;
- Enterprise Value (EV) – a measure of the company’s total value.
The investor will try to stagger the payments of the sale proceeds over a period of time, conditional upon certain objectives being achieved. For example, profit and returns of the investment. The seller should try and limit these conditions and get paid out within a year.
The question sellers need to ask themselves is – Should we remain in the business for a period of time, or exit immediately after the sale has been concluded?
The investors will probably want the family to remain in the business for a while to ensure continuity of knowledge and expertise. However, they only want this on their terms and conditions. Because they do not have any emotional attachments to the business and the people, they are clinical in their approach. Profits and returns are the order of the day and these may prove to be unattainable.
One thing is for sure, after the sale of the business there will be a culture change. The soul of the family and the business may be lost forever. On the other hand, the positive aspect is the value of the legacy is realised and the family’s hard work has been rewarded.
Business practitioners carry a significant responsibility when helping family businesses in distress. Family businesses bring a different dynamic to the marketplace. They are major contributors to the economies of most countries and employ a large number of people. If successful, they can be built into legacies for future generations and create wealth for all parties.