Two men shaking hands after a business transition with Private EquityFamily business owners looking to transition ownership of their companies are usually familiar with the traditional options. You can transfer the business to a younger generation of the family. You can find an outside buyer. You can sell to an inside management group, or to the company’s employees through an ESOP.

Another choice, though, is emerging as an option that compels many family business owners to think about what they want to happen to their company after they retire.

Private equity investment is a transition option that may appeal to business owners who want to position their companies to innovate and ride a new wave of growth after they retire. In some cases, children who are in line to take over a family business may educate their parents about how a private equity partner can come in with a minority stake to help the company succeed.

This is thinking outside the box about succession, which is what business owners on the cusp of transition should be doing these days.

Family Business Survival with Private Equity

The vast majority of private businesses in the U.S. are family owned, and they contribute roughly two-thirds of our GDP. But a distressing number of them don’t survive beyond two generations.

Marketplace needs change rapidly and many family businesses don’t respond effectively, instead satisfying themselves with serving the same customers with the same products until, one day, they realize their markets are disappearing. By the time owners are ready to sell, their businesses often command relatively low prices because no investments have been made in the technology, operations and marketing necessary to keep them relevant in today’s market.

That’s where private equity comes in. Where other types of buyers are looking for companies that have managed marketplace changes effectively and kept their systems up to date, private equity investors often look for companies that are hungry for new operational systems and marketing savvy. These are companies that have growth potential but need strategic investments to get to the next level.

Private equity investors often approach their investments differently. Many of them make immediate investments in IT, marketing and operating systems with the goal of driving up revenue and profits and then selling the company at a profit. Others limit their investments to companies in certain industries to take advantage of operational synergies and hold on to the companies indefinitely.

Two characteristics define nearly all private equity investors, though – the commitment to make rapid operational investments to boost profitability and a requirement to be involved in management, even if the investor holds a minority stake.

That may rub some business owners the wrong way. If you’re used to running your own show and answering to no one, the idea of working alongside – or answering to – an investor who has different ideas about running your business may not set well.

Benefits of Outside Expertise

But family businesses – particularly those that have operated without boards of directors or other outside advisors – can benefit from private equity investors’ expertise in the areas of strategic planning, financial management and controls and making strategic internal investments.

The key to private equity firms is to get in and find a product or service that they can scale up. They may take it from a local or regional enterprise to a national business. They are generally successful because many of the family-owned entities they invest in didn’t have the money to grow the business even if they saw the potential.

While senior owners of a family business usually are the ones to work with private equity partners when such a deal is made, inviting private equity investment into your company need not displace the next generation of family if they are interested in running the business. In fact, one of the benefits next gen owners have is agility and willingness to change things. They’re open to bringing in a fresh set of eyes.

Moreover, younger business leaders today have seen so much change in technology and markets, they’re not stuck in one place. They’re comfortable with change.

Today’s merger market is hot, and some business owners are receiving unsolicited offers that are far above what they thought they could get. It forces them to think about the emotional aspects of selling. If you’ve got a company that yields $1 million in EBIDTA and you plan to transition the business to your children, but now you’re getting an unsolicited offer based on a double-digit multiple, there may be a yawning gap between the two options and the kids come out on the short end.

But private equity investment may provide benefits that close that gap, as well as opportunities for your family to remain involved in ownership.

Baby Boomers still have a lot of time to transition their businesses – at least another five to 10 years – so the growing private equity trend is not likely to reverse anytime soon. Smart business owners will learn more about private equity as an option for transitioning their companies, so they are prepared when the time comes.

Brandon Miller headshot

Brandon Miller, CPA, CGMA
President & CEO