Easing Family Succession: How a Tailored Recap May Be the Answer

by Richard A. Vinci
Family and closely controlled businesses account for more than two-thirds of all businesses in the United States. Many family and closely held business owners start out with the admirable goal to pass the business on to their family members and/or long-term valued employees. Despite the genuine desire to see the continuation of the business in the family, only 30% of family owned businesses survive into the second generation and only 11% survive into the third generation with only 3% of all family businesses continuing through the fourth generation or beyond. These grim statistics have much to do with poor succession planning which is exacerbated by the lack of viable liquidity options for retiring family members.1As the statistics indicate, in most cases succession just happens rather than being planned thereby resulting in less than desired outcomes. Over the next decade, family-controlled firms will experience an unprecedented number of succession events. Since ensuring the continuity and success of the family enterprise is a top priority for most family business owners, these owners will be compelled to address some daunting and potentially unpleasant issues including, but not limited to, succession, control, tax planning and capital procurement for growth. Further complicating matters is the tendency for emotions to run quite high around the family succession of the business which can lead to messy litigation.A common theme for family business succession centers on the founders of a company approaching retirement age and their children, and those of the founder’s siblings seeking to succeed their parents and aunts/uncles in the business. Traditionally, family members seeking to retire from the business have required a liquidity event to monetize the value they have worked so long and hard to create in the business. The retiring owner(s) are often faced with needing liquidity from the business to provide for their retirement and know that it may be difficult to keep the company going and provide for the transfer of ownership to the next generation by selling the business to them. In many cases, the heirs have been groomed for executive positions and have full expectations of ownership, but lack the liquid financial resources to buyout their parents or to subsidize their retirement.

Accordingly, family business owners frequently may not be able to achieve all of their conflicting objectives and are forced into a total sale of the business or a transfer of ownership to the next generation without providing the requisite liquidity. As a result, the business may be disrupted; stability may be compromised; and capital may be insufficient for the company to grow and sustain its competitive advantage.

Conventional wisdom for creating liquidity tends to view the owner’s options as limited to taking the company public, establishing an ESOP, selling to a strategic or financial firm, or a debt recapitalization. The end result is frequently unsatisfactory and may lead to the company doing nothing or forestalling its succession strategy until a catastrophic event, such as a severe illness or death forces family members to react.

While it may appear that the former alternatives are the only viable approaches for providing liquidity for the retiring family members, an often neglected strategy is a customized equity recapitalization tailored to address the specific liquidity, growth and control requirements of the family and owner managed business.2

This type of transaction involves backing certain members of family management in buying ownership from the senior generation or from outside shareholders. Active family operators secure operating control and significant equity ownership, while bringing in an outside institutional financial partner for growth, management assistance and related support. The selling shareholders achieve liquidity to meet personal retirement, estate planning and diversification objectives. This type of transaction also ensures that the family business stays in the family and maintains its continuity. Further, this approach can be executed in a very discreet and confidential manner.

The funding for this type of recapitalization is traditionally provided by private equity firms with committed institutional capital focused on investing in family-controlled and owner-managed business. The managers/partners of these funds typically have significant experience in working with family business and have a special understanding of the unique issues facing family and closely held businesses. The objective of these funds is to work as a value-added partner in developing a strategic plan with appropriate incentives that align the interests of shareholders to create incremental equity value. The day-to-day operations of the business are left with family/owner managers.

In summary, a customized equity recap tailored to meet the specific needs of the family business is a proven method for easing the way for a seamless family succession plan. An equity recap can provide the much-needed liquidity to execute the plan’s strategy and help to insure that the family business is kept


About the author:

Richard A. Vinci is Managing Director of Newbury Piret & Company

(www.newburypiret.com), one of New England’s leading investment banking firms.  As a full service NASD licensed broker dealer, Newbury Piret provides Mergers and Acquisitions, Equity and Debt Financing, and Financial Advisory Services to middle market, family and closely held businesses throughout North America and Europe.

(1) Ward, John, Keeping the Family Business Healthy: How to Plan for Continued Growth, Profitability and Family leadership, San Francisco, Jossey Bass

(2) Collard, John, Value Creation Model: Build Enterprises Future Buyers Want To Invest In, Buyouts., Oct 4, 2004