Keeping Control of the Family Business via Private Equity Partnering

There are well over 100 different tools, techniques, strategies, tactics and combinations thereof that enable successful business owners to manage their wealth in accord with their values and goals. Discovering the appropriate combination must begin with clarity about the wealth holders’ values, goals, and loved ones, as well as the causes they hold in highest esteem. In companies owned by multiple family members, the need for clarity is compounded by the number of shareholders. Each will have a “horse in the race.” Therefore, a discussion of specific strategies or tools is futile, unless it is done in the context of exactly what the shareholders desire to accomplish. Because many of the tools, techniques, strategies and tactics involve irrevocable decisions, the importance of this clarity cannot be overstated.

A Private Equity Partner arrangement is among the strategies available to the owners of family companies. What follows is an example of how this technique was employed to resolve a major conflict among competing family interests.

Maintaining control of the family business and harmony among multiple generations of shareholders with divergent interests are major challenges confronting the owners of many family owned businesses. Other issues, including the desire for asset diversification by all shareholders and ongoing capital demands of the business, can create additional obstacles to peaceful co-existence. Frequently, indebtedness incurred to buy out inactive shareholders severely restricts a company’s ability to expand and, in times like now when credit is tight, can lead [to its demise.

The presence of a restless bloc of shareholders precipitated the agreement to sell a substantial interest in Freedom Communications, Inc., at the time, one of the country’s few remaining family owned media companies. Founder R. C. Hoiles started the company in 1935 with the purchase of the San Ana Register and expanded it into a media conglomerate. Freedom’s assets included eight television stations, 27 daily newspapers and 37 weeklies. Daily circulation approximated 1.2 million subscribers.

Citing the company’s underperformance in recent years, older family members demanded a buyout of their shares or an outright sale of the entire company. Another group of Hoiles’ descendants, representing approximately 40 percent of the company’s voting stock, argued that the value of keeping the business in the family and protecting its unique philosophical heritage outweighed the financial rewards of selling out to a competing media concern. This was clearly a case where clarity between the shareholders and their advisors about their true goals was required to arrive at an acceptable solution.

To address the conflicting objectives, the company’s board of directors elected to partner with Blackstone Communications Partners and Providence Equity Partners to purchase the stock of the older family members under an agreement that enabled remaining shareholders to retain operating control of the family business. Funds provided by the equity firms and a JP Morgan Chase Bank debt facility were used to make the purchase. Competing bids submitted by Lee Enterprises, Inc., E.W. Scripps and Gannett Co., Inc., publisher of USA Today, would have resulted in a sale of all of the company upon approval by a majority of the shareholders. Ultimately, these alternatives were discarded as inconsistent with the goals of the younger generation of shareholders.

Private Equity Sources

Blackstone, Provident and other prominent private equity groups continue to provide a flexible and dependable source of capital for established, family owned companies. Investors in these funds include public and private entity pension plans, major universities, insurance companies, investment banks, and high net worth individuals. Private equity transactions can take the form of leveraged acquisitions, buyouts or recapitalizations. There is substantial latitude in the structuring of each deal to accommodate the unique requirements and objectives of the various shareholders in the family business. In the Freedom Communications transaction, for example, Provident and Blackstone purchased a substantial position in the company while leaving key family members in control.

After making an investment in a family business, private equity partners will seek to continue or accelerate its growth. Through a base of professional relationships, equity partners can create business development opportunities for the company. The group can offer financial expertise, access to strategic industry relationships and resources, and serve as a primary source for additional growth capital. The investment in a family owned company by a prominent private equity firm provides additional credibility to the business and a solid foundation for its future expansion or sale.

Capital Availability

Private equity firms are under increasing pressure from their limited partners and other capital sources to invest idle funds. John L. Chapman, PhD and NRI Fellow (Economics) at the American Enterprise Institute estimates that the worldwide volume of private equity capital exceeds $1.4 trillion, and that $800 million of that total is held by domestic PE firms. This abundance of capital, combined with a relatively limited number of attractive target companies, has generated intense competition among private equity groups, hedge funds and corporate acquirers to consummate transactions. As a result, valuations, as reflected by multiples of EBITDA (earnings before interest, taxes, depreciation and amortization), are steadily increasing for family-owned businesses that are performing well. Moreover, the private equity firms have become much more flexible in negotiating the terms and structures of their equity investments.

Ideal Candidates for Investments

Although private equity firms are as diverse as the operating companies in which they seek to invest, there are many common characteristics that private equity investors find attractive in potential candidates. In general, these investors look for well-managed companies, which generate annual operating income in excess of $1 million. Many funds have significantly higher earnings thresholds. On the other hand, companies pursued as “add-ons” for an existing company within an equity fund’s portfolio of businesses may be somewhat smaller. Targeted businesses may compete in a broad spectrum of industries and supply a wide range of products and services through diverse distribution channels. Accordingly, successful manufacturing, wholesale, retail and service businesses are of interest to these seasoned investors.

Conclusion

What criteria do private equity firms when evaluating potential investment opportunities use?

These include:

• Consistent and growing businesses
• Stable revenue streams
• Expansion opportunities
• Predictable cash flows
• The current market position of a business within its industry
• The presence of meaningful barriers to entering the company’s market segment or geographic region.

Finally, a Private Equity Partner will seek assurances that remaining family members and operating managers will continue with the enterprise and endeavor to increase sales and profits to achieve maximum value for all shareholders.

Charles L. Stanley CFP ChFC AIF. In addition to many published articles and quotes in the financial press, Mr. Stanley regularly conducts continuing education classes for Attorneys and CPAs and is available for public speaking, seminars and private consultations. He is also a wealth manager with Capital Financial Advisors, LLC, a fee-only Wealth Management Firm in La Jolla, CA whose mission it is to provide Wealth Management to Successful Business Owners. Mr. Stanley can be reached at 858-395-8694 or cls@charlesstanley.cc or www.charlesstanley.cc

Lynn Ryder Mason, JD is a principal with Global Capital Markets, Inc., an international investment banking concern, and manages the firm’s San Diego office. He can be contacted at 858-676-6880 or lm@globalcapitalmarkets.com