Acquisition of a family business

Lower premiums when selling a family businesses – why?

Family businesses face many challenges these days, including the constant question of how to succeed in today’s increasingly fast-evolving business ecosystems while maintaining their corporate identity.

Many family businesses are therefore changing their established approaches to business, and many of them are also starting to merge or even actively engage in acquisitions that go beyond mere alliances. On the other hand, various studies examining acquisitions of family businesses have found that the premiums paid for the acquisition of small and medium-sized family businesses tend to be lower than those paid for the acquisition of larger businesses.

Are there significant differences between mergers and acquisitions of family-owned and non-family-owned businesses? And if so – which ones?

The gaps created between owners of small and medium-sized family businesses, their advisors and financial funds

Whether a family business is on the buy or sell side of a transaction, we know that family businesses have a different view of M&A than the rest of the commercial world. The former take a more emotional, personal and experiential approach to transactions, often unconventional compared to the usual approach.

In the case of acquisitions of family businesses, three major gaps can be identified between the owners, their advisors and the equity funds when they act as investors:

• • Financing gap. When it comes to accessing external finance, small and medium-sized family businesses use different types of finance than the rest of the business community. They tend to follow a conservative order of fundraising, preferring to use funding from retained earnings, loans from family and friends, and perhaps subsidies. Investment by private equity funds, however, is more the norm than the rarity. They thus operate with less financial resources than would otherwise be possible. Research has also shown that the larger the private equity funds, the less likely they are to invest in small and medium-sized family businesses. The main reason is usually inadequate, undersized targets. Similarly, small and medium-sized family-owned businesses have a reluctant attitude towards working with private equity funds. Interestingly, many of the SMEs surveyed hired inappropriate advisors, whose lack of experience and understanding of M&A processes further widened the gap between one side and the other.
  • Knowledge gap. SMEs are usually not familiar with the private equity industry, all the possible ways of financing transactions and the criteria used by funds to judge investments. Moreover, in the sale process, family businesses are usually reluctant to disclose to PE funds the financial information they need for due diligence. The research shows that the knowledge gap is more prevalent in smaller family businesses. Small and medium-sized family businesses often did not know what the right price for their business was and often sold it below cost. This is because private equity funds usually lack knowledge of the dynamics within a family business and may misprice it. It is therefore crucial to work with an advisor who can explain the financial investors’ perspective to the family business and help to structure a transaction that is acceptable to institutional investors.
  • Empathy gap. In some studies, there has been resistance between family business owners and financial institutions, particularly private equity funds, because of different views on the objectives that the business should pursue.

Despite studies suggesting that family businesses are a good investment, the premiums achieved are lower when selling them

Many studies suggest that family businesses are a better investment in the long term than non-family businesses. This is due to the special care that the family puts into the management and running of the business – either the family looks after the employees and customers, or the family is more careful in business decisions, has a tradition and puts extra effort into developing the business for future generations.

However, in practice, premiums for family businesses tend to be lower than those for the rest of the commercial business. Therefore, working with a professional adviser experienced in M&A and larger transactions, where financial funds are usually present, is key to bridging the gap between owners and funds and consequently maximising the purchase price for owners.

Based on: LEP, T. (2020). The Value of Advisors to Business Owners in the Process of Selling an Equity Stake. Ljubljana: University of Ljubljana, Faculty of Economics.