Selling Family-Run Businesses

Businesses owned or operated with the involvement of more than two family members are generally considered family-run. Many family-run businesses are quite successful due to the expertise and longstanding collaborative efforts of the family members active in the business. Indeed, over 40% of family-run businesses are passed down to the second generation, assuring a legacy of lasting importance in the community. The customer goodwill and powerful competitive advantages often created by many family-run businesses attract many types of buyers when it comes time to sell including competitors, private equity groups, and entrepreneurs seeking to carry on and expand the business. At the same time, replacing the roles and goodwill associated with the active family members involved in the business must be incorporated into the valuation.

Align Goals of Family Members

The first issue that must be addressed prior to selling family-run businesses is aligning the goals of the family members involved in the business. This way, each family member that either works in the business or owns part of the business will cooperate with each other and with the buyer during the selling process. No family member should be felt excluded from the selling process. Further, the family members must determine whether the sale of the business should be to an external party or should be to an internal member of the family (or even to an employee). Many times, family members obtain a professional business appraisal by a business broker experienced selling businesses in the industry in which the business operates in order to determine whether an internal sale is feasible.

Create Transitional Plan

Prior to selling, the sellers of a family-run business must also create a transitional plan in which to help the buyer retain the goodwill of the business. The transitional plan should cover how the company’s customer base, staff, and supplier relationships will be conveyed to the buyer. Additionally, the transitional plan should provide insight and guidance as to how best retain the company’s competitive advantages (ability to sell products or services for a better price or quality than its competitors). Transitional plans for family-run businesses should address the roles played by each active family member and how their roles may be replaced. For active family members desiring to stay working for the buyer after the sale, the transitional plan should note their desired salary and role. For active family members not wishing to stay after the sale, their replacement salaries should be estimated along with concrete suggestions as to how their roles will be replaced.

Adjust Owner Benefit for Salaries of Family Members

When selling a family-run business, its business model must be individually examined and put into proper context in order to determine its adjusted owner benefit (or true economic profit derived by a working owner) used for valuation purposes.
A multiple of the owner benefit (2-4x or more) is then used to generally determine the value of the business.
For a family-run business with multiple working family members, however, ascertaining the properly adjusted owner benefit that a buyer may derive from the business requires adjusting each family member’s salary (or absence of a salary) in relation to their replacement costs.
Some family members may be paid more than their replacement cost while other family members may be paid significantly less than their replacement cost.
Other family members may not be paid a salary at all or may have special skills and talents that are especially difficult to replace.
In general, the salary of one working owner may be considered part of the adjusted owner benefit since it is reasonable to assume that a buyer may personally replace one working owner.
This general rule though does not apply in some situations such as a small family-run small restaurant where it is reasonable to expect that a buyer will operate the business with their family members or multiple partners.
Otherwise, each working family member’s salary and benefits must be closely examined.
Overpayments above and beyond their replacement cost is considered part of the adjusted owner benefit since a buyer would not incur such costs.
Underpayments to family members below their replacement cost reduces adjusted owner benefit since a buyer would incur extra expenses in replacing the active family members.

Example of Adjusting Owner Benefit for Salaries of Family Members

Sal owns and operates a plumbing supply business and is seeking a business valuation. Sal’s business generates $5M per year in sales and employs Sal’s three daughters. Each daughter makes $150K per year and do not wish to stay in the business on a long term basis. Sal’s transitional plan states that the buyer may replace Sal’s daughters for $75K/year each (the current market-based salaries), and further states that the daughters will continue working in the business after the sale (for $75K/yr each) until their replacements are trained and hired. Here, while Sal’s salary is considered part of the adjusted owner benefit, the daughters’ salaries are adjusted to reflect their replacement costs. This results in the adjusted owner benefit used for valuation purposes being increased by $225K (3 x $75K) to account for the buyer’s savings in replacing Sal’s three daughters.

Valuing Family-Run Businesses

The valuation multiple of family-run businesses applied to the properly adjusted owner benefit ranges from 2-4x or more. Primary valuation factors include the physical assets, historical growth rate, and the transferable intangible assets retained by the buyer after the sale. A well developed transitional plan helps reassure the buyer that the goodwill may be retained after the sale and thus elevates the valuation multiple. This is why certain family members agree to continue working several years after the sale in order to ensure a smooth transition to new ownership. The greater certainty in which the buyer believes that the advertised level of adjusted owner benefit will apply to them as a working owner (rather than to an entire family) then the higher valuation multiple they will be willing to pay.

Family-run businesses that are not passed along generational lines often are put up for sale upon the founder’s death or retirement. It is always best to plan ahead for such an eventuality by thinking through the issues that a buyer would confront upon owning the business and developing a clear transitional plan. An experienced business broker should appropriately price the business based on the properly adjusted owner benefit in order for the seller to receive a premium purchase price with generous terms.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.