Jacoline Loewen, director at Loewen & Partners, calls it “the red-face experience”—a testy exchange she’s experienced numerous times during her career as a broker of private-equity deals.
An owner-operator has reached a stage when he should step back from the business, either for the good of the firm, or for personal and family reasons.
But the owner, usually a man in late middle age, won’t hear it.
She recalls a 57-year-old inventor who’d turned a biotech patent into a $50-million-a-year enterprise. Family members worked in the company, but not in senior management; well-paid executives held those positions, but had no ownership stake and thus little motivation to rock the boat.
When Loewen met this entrepreneur, it was apparent trouble had been brewing for some time. He needed to push the firm to the next stage of growth, but seemed unwilling to take that step.
He also had complete control, and no one near him had the gumption to open his eyes to the emerging business threats. Loewen’s suspicions were confirmed when the man’s wife called to fret about the situation behind his back.
“None of them wanted to say, ‘The emperor has no clothes,’ ” she says. Brought in to present the possibility of bringing in a private equity investor, Loewen showed the owner, who’d been working since his late teens, a diagram on how the risk profile for owner-operated businesses rises sharply as an owner ages.
“He just got really angry,” she recalls, noting the rising colour in his cheeks. “He said, ‘This could apply to other 57-year-olds, but it doesn’t apply to me. I’m going to be working until I’m 90.’ ”
Cure Founder’s Syndrome
Most advisors who’ve dealt with entrepreneurs understand that for many, the sources of their drive and talent can turn into liabilities later in life.
They’re headstrong, tireless people whose sense of identity is tightly bound to the enterprise. And they have great faith in their own instincts. So when the time comes for an owner to think about selling the business or passing it to adult children or senior managers, experienced advisors must find ways to frame the transition as a positive opportunity to embark on future philanthropic or mentoring projects.
“The most challenging part of all this is seeing beyond the sale of the business,” observes Sue Van Der Hout, a director with Vestra Advisors and a family-enterprise instructor at the Schulich School of Business. “ ‘What am I going to be afterwards?’ That is the unspoken anxiety that many owners experience.”
Indeed, to persuade a client to sell all or part of the business, advisors must show the owner that such a decision offers crisp and sustainable solutions to potentially calamitous problems, including the absence of a suitable successor from within the family or the firm, and excessive exposure to business failure.
Advisors who’ve persuaded owners to sell say they’ve appealed to their client’s desire to ensure the wealth that’s been tied up in the business is available for the next generation, a goal that in some cases may only be achieved when the firm brings in a strategic buyer or a private equity investor.
Denial is a common reaction: “A lot of these individuals, particularly founders, aren’t looking for truth or advice,” observes Ted Polci, TEP, a partner with First York Insurance Agency Ltd., in Toronto. “They’re looking to get what they want.”
He tells of being called in by an accountant to provide advice for a $30-million-a-year firm owned by a man in his late 60s whose daughter, an MBA, was operating the company. The owner was taking a lot of money out of the business but hadn’t relinquished meaningful control, and wasn’t paying his daughter well. “He was still treating the business as his piggy bank.”
Polci offered frank advice: “You can’t keep running the company because you’ll lose your daughter.” It wasn’t news the owner wanted to hear: “Basically,” Polci recalls, “we didn’t have a relationship after that.”
As Polci’s story suggests, it often becomes obvious to people around the owner—either anxious spouses, impatient adult children in line to take over or increasingly frustrated senior managers and other professional advisors—that succession is the key to survival and growth.
In some cases, the company has a shareholder agreement with a shotgun clause allowing other partners to vote to buy out an owner-operator who has lost the ability to manage the business.
Such measures, though, don’t apply when the entrepreneur retains full control. What’s more, pressure to sell is often about much more than the current viability of the firm. For instance, spouses who’ve watched the family’s savings pour into the business for years worry that its intrinsic value could vanish.
Yet it requires a deft touch to persuade a reluctant owner to have a constructive dialogue about how to transition the business.
For advisors, observes Thomas Deans, author of Every Family’s Business, the challenge will only grow as baby boomers retire in large numbers.
So it’s never too early to raise the subject of transition and succession with an owner-entrepreneur. Grant Galbraith, a chartered accountant and managing partner with Collins Barrow’s Halifax office, says succession planning is often a very long process.
“It’s a recurring exercise. Bring it up every time you see them and make sure they understand how purchasers will look at the business,” he says.
But Loewen points out the most significant impediments invariably involve the owner’s psychological make-up and family politics.
“You have to understand what the roadblocks are.” And that means confronting the owner’s fears.
Van Der Hout begins by posing three hefty questions to clients who are facing this situation:
- What keeps you up at night?
- Where do you want to be two-to-five years from now?
- What is the story of your family?
She also suggests advisors seek permission to reach out to family members, a spouse or advisor to gain insights into the way an owner is thinking about such changes. “They can help engage on the back story and in background discussions that help take you from meeting to meeting,” says Van Der Hout.
When it comes to probing the fear of a future filled with golf, stock trading and not much else, Loewen asks her clients to identify businesspeople they admire for the way they’ve arranged their retirements.
That may entail looking for opportunities such as directorships on charitable boards, or finding ways to use their wealth to guide younger entrepreneurs.
“If you can give them a bigger dream to reach towards, that really helps.”
What they really want
Van Der Hout stresses it’s critically important to discuss the family’s values and the entrepreneur’s aspirations for the next generation, because “these kinds of people and families […] want to keep their wealth and do right by the business and their employees.”
Others, however, take a more targeted approach, focusing on the owner’s risk in maintaining the status quo.
Polci says he’s often encountered entrepreneurs so heavily invested in their own companies that they’ve neglected to put their savings into something as basic as RRSPs. One simple solution: an owner can boost his compensation and dividend payments.
Deans says owners who put all their funds in one basket are ignoring basic rules of asset allocation, hedging and portfolio diversification as a means of limiting risk.
To drive the point home, he lays out a risk scenario in which the owner suddenly dies and the shares are transferred to the spouse, who’s forced to sell them at a steep discount because the entrepreneur hadn’t readied the firm for his departure.
For owners who see reason and entertain succession, there are several standard approaches, including selling a portion of the firm’s shares to adult children or a management team that is interested in a stake in the company.
But if the next generation or senior executives don’t want to—or can’t—take over, the owner can sell to a strategic investor, a process that requires significant preparation and a team that includes tax and legal experts as well as M&A advisors.
Tracey Strauss, a partner with Collins Barrow’s Toronto M&A practice, notes owners and founders often have unrealistically high expectations about the value of their firms. So in preparing for a strategic sale, she says, M&A experts will look at the value of comparable companies and propose strategies to improve the firm’s balance sheet.
Yet Loewen points out reluctant owners often neglect to look at the private equity space and exempt market dealers for investors who may be willing to buy a long-term stake in the firm, even without securing seats on the board of directors.
Such a move, she adds, paves the way for an extended transition, with the owner or founder potentially retaining an office and a role through an employment contract, even as the PE firm installs professional management with an eye to boosting performance for an eventual sale. These partners, Loewen says, “aren’t necessarily gorillas.”
In certain cases, however, the owner simply isn’t ready to budge. “If the owner is not signed on to the transition process,” notes Van Der Hout, “all the planning in the world won’t position the business for a transition or sale.”
Indeed, with such clients, savvy advisors will take a step back and allow the owner the space to investigate all the alternatives and options available to them. “It’s really important to allow it to percolate,” Van Der Hout adds. “You have to meet these people where they are.”
John Lorinc is a Toronto-based financial writer.