Attorney, Paradigm Counsel
We live in a very interesting time. The current global economy and geopolitical climate has many risks and pitfalls; yet, the U.S. economy, stock market and capital markets are riding peak levels on the back of Fed policy. All of this has driven an incredible spike in mergers and acquisitions with deal activity at record levels and valuations meeting – and often exceeding – the peak levels seen in 1999 and 2007. Many family businesses that missed the 2007 peak market window are now able to reconsider their liquidity and succession alternatives, given the valuation of their business has likely risen back to and above the levels they saw pre-2008.
The most interesting aspect of this M&A market for family businesses is that – for the first time in my 20 year career – financial buyers are offering valuations that now often exceed strategic buyer, or competitor, figures. The age-old truism that a family had to sell to a competitor in order to maximize value is out the window. There is a new win/win option: selling to a financial buyer, such as private equity firms or family office investors. The historical “either/or” trade-offs are no longer valid. A family can now achieve maximum value for the business they have built, and at the same time remain independent, take care of their key management and employees, and obtain capital to drive acquisitions and future growth creating increased opportunities for their employees and community.
The key reasons for this change are the low cost and abundant debt capital markets, a material reduction in private equity return thresholds, and a hyper-competitive market where the supply/demand imbalance clearly favors the family business. According to Pitchbook, there are now over 4,700 private capital funds with a combined available capital for investment exceeding $376 billion. Factor in a typical debt-to-equity ratio, and there is well in excess of $1 trillion of buying power in the hands of private equity right now. This tremendous oversupply of capital is driving valuations being paid by private equity buyers to peak levels not seen before, and offering a nearly limitless range of alternatives in structure for family companies to optimize a transaction.
Cascadia Capital has witnessed this trend first hand in its long history of working with family owned businesses. In the 13 year period from 1999 to 2012, we sold only a handful of companies to private equity firms. Strategic buyers nearly always paid more. Now, in the brief two-year period from 2013 to 2014, private equity firms have been involved in 18 of our deals, winning nearly 50 percent of our deal processes. Recent examples include Span Alaska receiving a majority investment from Evergreen Pacific Partners and TrojanLitho being acquired by Arbor Investments.
This trend isn’t just limited to the Pacific Northwest or specific industries; it is occurring nationally and across all industries, even cyclical industries such as building products, manufacturing and aerospace. The disconnect that we are seeing in the Pacific Northwest however, is that family business owners are not necessarily aware of this private equity phenomenon, nor the full range of opportunities available to them.
This market opportunity is equally attractive for all generations. For the elder generation, a private equity deal offers liquidity at a very favorable valuation, rather than an internal succession plan that often leaves them at risk with minimal or no liquidity, and a 10 to 20 year payout period. For the younger generation, a private equity partner offers the ability to take more risk and more aggressively grow the business to the next level. A shift to private equity ownership can help avoid what can be a generational conflict where the elder generation is risk averse, seeking to preserve value versus grow value, while the younger generation feels they are left unable to take full advantage of growth opportunities for their family business. Also, a private equity partner can bring a lot of value-add beyond capital, guiding the younger generation at the board level to improve governance, financial management and efficiencies, assisting in strategic acquisitions, and making the family business even that much stronger.
A family business now has a “Baskin Robbins” 31 flavors of deal options available to them. They can do a minority deal or majority deal. They can partner with a long-term minded family office, or pursue a more typical 4-7 year exit window with a private equity firm. They can avoid private equity altogether and do an internal recapitalization, taking advantage of the peak debt capital markets. Anything and everything is possible right now.
Family business owners are now able to focus their thinking more on the qualitative ways to optimize a transaction. In a traditional strategic buyer situation, a family business typically can only sell 100% of their business in terms dictated to them. In today’s new paradigm, a family business can first think about what would be the optimal transaction and deal structure for the family, management, employees and community, and then dictate those terms to the market. Each family is different, offering the opportunity for them to individually and collectively dream up what is most important to them, and weave those requirements into the deal terms. Key components to consider may include:
Sharing equity with key management
Maintaining a minority interest to keep family ties to the business
Maintaining headquarters in your community
Growth capital for acquisitions
Assurances of maintaining product quality
Securing manufacturing on-shore in their community
For the first time, family owned businesses have a unique opportunity to complete a financial deal that includes all critical qualitative and quantitative components, without making significant concessions on value for the family business. The question becomes, how long will it last?
Companies that considered selling their business in 2007, but opted to wait for a higher valuation the following year, had to wait seven years for valuations to come back to prior peak levels. Thus, the question a family business should consider now is whether they can wait until the next cycle, or would they prefer to explore some type of liquidity transaction today. With interest rates expected to rise between 2015 and 2017, the current valuations and capital availability should last through 2015, but it becomes less clear getting into 2016 and beyond. If we learned anything from the 2007 recession, it is that economic cycles must be considered in the strategic decisions of a family business.
The window of opportunity will not remain open forever, so if you are considering an exit, start the conversation with your family today to determine whether you should take advantage of the new alternatives in this market or not. This is the kind of market where you do not want to miss out on at least considering your options and having the in depth discussion as a family to evaluate the right path for your business.
Christian Schiller is a Managing Director at Cascadia Capital and is a leader in the family business segment across the Pacific Northwest, working proactively with family business leaders to facilitate various strategic initiatives.