Be Ready When You Get the Call: Dealing with Buyout Suitors
by Shel Horowitz
In industry after industry, consolidators roll up the small fry in their big nets-either aggregating the little companies into one large entity, or trampling smaller firms with chain-owned superstores that make it hard for small family businesses to compete on price or selection.
At the Family Business Center's April meeting, four panelists looked at different pieces of the consolidation game-and how family businesses can thrive and prosper when the consolidators come knocking. Richard Narva of Genus Resources, Dirk Dreux, a former president of State Street Bank of Connecticut who now works for the Family Business Center's counterpart in Storrs, Connecticut, Rich Dino, director of the UConn Family Business Program and Associate Dean of the UConn School of Business, and Barry Dickstein, a venture capitalist with Acquisition Funding Partners, of Simsbury, Connecticut.
These bottom-line driven consolidators, said Narva, "answer to only their financial constituency." Traditional businesses have to answer to employees, stockholders, and the community, and, when faced with consolidators, it's "a fundamental change of values." Dreux called this trend "predatory consolidation" and warned that things are not always what they seem. They are looking for information. They hold out the promise of El Dorado so they can get in, get a confidentiality agreement, look around, look at the numbers. When you get the pitch that says you may be worth 11 or 12 times EBITDA [earnings before interest, taxes, depreciation and amortization], remember that they may want to learn on your nickel.
And all the threats to a business are not immediately obvious. Said Dino, "This can cause an implosion in your business, in your family, and in your money." If a Home Depot-style competitor moves in, the question, "Do I stay, do I leave, do I fight?" can "jeopardize family businesses' independence, prosperity, and survival."
Narva put it slightly differently: "The last thing anyone in the acquiring business even talks about is family. You can have great numbers, fully agreed upon goals. But if you're in a family, you're confronted with issues of issues of power, control, money. Unless the family has the skills to permit it to talk about emotionally powerful issues, when [they buyers] are waving [money] around, what happens to families? Nothing good! People have values other than just making money. They think back and forward through generations before their first cup of coffee in the morning."
Still, Dickstein, who puts together funding deals for buyouts, painted a rosier picture, saying the value of a company was not necessarily what the current owner had done with it, but what the prospective owner could potentially do. Through a mixture of "senior debt" (relatively inexpensive bank and similar funding, good for up to about 65% of a business's value), "mezzanine loans" (subordinate to the senior debt and more expensive, putting in additional funding above the senior loan up to about 80% of the business value), and equity funds that cover up to and slightly above the remaining value of the company in exchange for an ownership piece, a business could sell to its management team or be bought out by a hungry competitor.
Yet even in this well-oiled world, all is not perfect. If a company fails to make its income projections, Dickstein acknowledged that the new management would lose control of the company to the funding sources. Narva commented, "You have to ask if the roller-up has the competence to run the entity. Otherwise your stock will be worth 30% of what it was on the day you sold."
How real is the specter of consolidation? Dino named over a dozen industries where the demographics make consolidation very likely. Any industry with a lot of little fish and a diffuse market share is a potential target, from printing to HVAC. Even the eye care industry is up for grabs, with some 45,000 practitioners dividing a $20 billion domestic market. And, as Dreux pointed out, it's "not just a question of your industry being consolidated, but the people you buy from and sell to have changed." He cited one company that used to be able to choose among 50 suppliers. Only one supplier remains.
Family businesses, which are usually much more naive financially than consolidators, are prime targets, especially as they move toward outside management. Dreux: "You start to go to outsiders for resources. The management section will start to dominate. Most consolidators want to get the professional manager on board and eat "the family and owners. and Dreux noted the irony that many venture capital buyouts are funded by family business pension investments. "It's ironic. the people who'll be put out of work are the ones funding it."
Dreux also pointed out that every funding option has trade-offs. "There is always another transaction. Look at the scenarios, the price, tax implications, competitive and management implications"-AND the values and corporate culture."
Narva again got right to the heart. "Talk about core values. THEN you know whether selling the business makes sense." Family business owners "don't have jobs, they have passions. they don't retire; they die."
And one way out for family businesses under siege is to become the big fish. Narva cited a family business owner who began swallowing competitors. He had built strong relationships with them, and "everybody took his call," even if they had no interest in selling. "He takes care of the people, and he can buy up companies the equity funds can't reach-because they have relationship equity."
Narva's advice: skip "the Viagra approach" that's only good for an hour. Decide: am I a buyer or a seller. Learn how changes affect your firm. Watch industry trends. Get the corporate finance skills you need. spend some money on competent and trusted advisors and do the analysis before you ever get a buyout inquiry. Finally, don't feel you have to expose all your vulnerabilities. Don't be like so many business owners, who "throw out every copier salesman but spend hours answering a form letter and divulging all kinds of information.