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The IPO Itch: When Consolidators Come Calling

"I just don't know what I want to do," said 48-year-old, third-generation president of a regional industrial distribution company. He'd recently received a proposal from a self-described "team with strong Wall Street experience" to "consolidate" his family business with half a dozen or so others to reach "critical national mass" and go public.

The documents supporting the proposal were quite impressive. The company president was used to calls from business brokers and others expressing interest in selling or buying the business. Some had already acquired other old friends in the industry for cash. He knew those deals and he knew he could easily find a buyer if he wanted to sell.

"I like my life and my career," he explained. "I like my independence. Of course, I have to deal with Dad. He's 'semi-retired,' and you know what that means. And my two sisters will own half the business, and I worry about their needs long-term."

"But, in 5-to-10 years, I'm not sure that a regional independent will be able to survive in this industry."

Increasingly, leaders of family businesses find themselves faced with such decisions. Where owners traditionally found it difficult to sell even if they wanted to, today's financial operators increasingly focus on mundane, fragmented markets where family businesses have thrived for generations. How to respond?

To Sell or Not To Sell?

Some family businesses simply say, "We are not for sale." The risks of that posture, however, include pride, stubbornness, or overconfidence. It is the right answer when commitment and the capacity to manage change permit a family business to remain independent as a niche player, as one who can truly provide added value through unique products or services in a clearly defined market, or as one driving, rather than riding, consolidation waves.

Some family businesses say, "We will sell, but only for a once-in-a-lifetime price and terms." In fact, some consolidators are willing to make such deals with very strong players in important markets. To make the approach work, you must deal from strength, understand the motivations and values driving the consolidators, and be willing to play hard ball in negotiations. Timing is also important. While consolidations sing an attractive song, the first suitor may not be the right one and the first deal (particularly if the goal is an initial public offering) may not be the best structure. And even if the deal's structure is "right," what is described as "getting in on the ground floor" may in fact mean "falling into the sub-basement." IPOs often decline in value initially making later rather than sooner a potentially better time to sell.

Slicing the Ownership Pie

A typical IPO consolidation deal gives the consolidators 15% ownership, the public 30% and the businesses rolled up into the deal about 55%. In a recent example, for an investment of about $2 million and about 9 months, the consolidation team's reward was anticipated to be about $22 million. The family owners joining the deal contributed their businesses which had required an average of 50 years to build. They received the value of their businesses in cash (30%) and stock in the new entity. Any premium would be determined by the stock market. One can legitimately ask whether such pies are being appropriately sliced.

Does this Deal Answer Your Needs?

For some family businesses, such consolidation deals scratch exactly the right itches: Family conflicts or waning commitment; liquidity; freedom; diversification; greater management challenges and opportunities with accountability to market rather than family concerns; and many more.

But be careful. An inactive family member's desire for greater liquidity for example, or a president's desire not to go to daddy for a raise, are issues that can be resolved in ways much less dramatic than giving up control of the business. Sometimes real business benefits result: economies of scale; experienced financial and operational management; better service to national accounts; more attractive career paths and compensation packages for key employees. Such stories sell IPO shares.

Other times, the story just doesn't come true. Over-emphasis on finance versus other success variables, creation of bureaucracies, assumption of unrecognized risks and liabilities, loss of the "personal touch" achieved by family-owned businesses, lead to performance not living up to promises or even outright failure.

How to Make the Right Decision

The decision to contribute a family business to an industry consolidation strategy is not an easy one. Our best advice is to fully understand the goals and values of your family owners, individually and as a group. Then get the best professional advisors available, experienced in dealing with family businesses confronted with such deals. Finally, don't be in too much of a hurry or underestimate your own value and strength.

Get your family on the same page as to whether they even wish to consider such ideas. Then analyze the particular deal, deciding if this is the way you want to go. Consider alternative structures and approaches. If a particular deal seems to offer the right approach, then analyze the deal itself. Is it right and fair, and does it give you your due? Are the people folks with whom you want to bind your long-term interests?

While the president of the company that started this case study was discussing the consolidation proposal with his father and sisters, the family remembered what their grandmother used to teach them. "Life is just one adjustment after another," she said. Family businesses that prosper make those adjustments in ways that are smart for the family and for the business.

 

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