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Sell in, not out

Melanie Stern is Section Editor of Families in Business magazine.

You don't have to throw your company to the lions when the time for exit approaches. Melanie Stern examines how selling to your managers or staff can provide another way out

Yeah, yeah, yeah – so we know that business-owning families have never sat pretty with the idea of exiting by selling their beloved companies to a rival, and even less so with going to market.
They've never really had to; many families, particularly in the UK and other parts of Europe, have found a happy medium in management buy-outs (MBO) or the slightly lesser-known employee buy-out (EBO).
Selling in, instead of out, carries some key benefits for the family-owned company. Transferring power from the family to an incumbent group means it retains its owner-manager status and the implied extra commitment to results that goes with it. Secondly, these types of exits protect hard-earned brand equities, critical business data, trade secrets, and valuable staff with specific knowledge from being handed over to a purchasing rival. Thirdly, they save on the time, money and the risk in a floatation, though both these options can be used as part of a longer-term plan to prepare for that in the future.

Overall, it's generally a continuity choice and could well have more than a little to do with families having a hard time letting go of their companies emotionally, even if they will having nothing to do with them post-exit.

"If the focus is purely on maximising the value of the business and value for shareholders, a family will consider every possibility for exit from trade sale to IPO," explains 3i's UK private equity expert, Kevin Lyon. "But if, as is often the case, the family's name is above the door and the ownership is spread across many generations of ownership, there are often different drivers behind that business – managers usually see their role as custodians of a business to pass on to the next generation rather than being just owners, so to then sell to a rival is a real issue. There is tremendous loyalty in most multi-generational companies."

David Erdal, managing director of UK EBO advisory and structurer Baxi Partnership, has faced this choice. He led his first EBO as chairman and fourth generation of his family's company, paper manufacturer Tullis Russell, ten years ago.

Some family shareholders wanted capital from the company, but others were committed to the company's future. Both groups, however, agreed they didn't want to put the staff at risk by selling up or floating.

In the mid-1980s, Erdal set up an employee share scheme and began buying up small family shareholdings over a number of years, filtering them to the staff.

A full EBO was completed in 1994 with each party represented by a different merchant banker, realising £36m for the family and ensuring a smooth succession out of family hands. The shares are now held by a trust managed independently, and are distributed to staff annually. Erdal brought in a strong management team to realise the direction of the new shareholders, and the company subsequently outperformed its market for many years after.

EBOs are not as commonly reported as MBOs and not as well-recognised by exit advisors, Erdal believes, because of a sort of socialist-uprising inference in employees having control over management. "The merchant banker we consulted for the Tullis EBO recommended quite strongly a floatation or trade sale, and it took us about three years to convince him that we were for real with this idea. Once that happened, he became an enthusiastic supporter. But it is a question of tradition – there is simply a prejudice against EBOs because they're viewed in the same light as a democratic managementm – they're afraid of losing control. Managers of EBOs manage with participation but their performance improves dramatically when everyone is on the same side."

For the Erdal family, this choice fulfilled their aims.

"The family understood that an EBO would provide them with the cash they wanted, but would do it with consistency of ethos handed down family generations," Erdal explains.

"We didn't want to betray the employees who had helped us build the company. [The family] got its capital without selling out to a rival who could have massacred our staff and run the company into the ground."

Husband-and-wife founders of UK clothing chain Hobbs, Yoram and Marilyn Anselm, chose the MBO exit route when it was time to retire and there was no successor option. In 2001, MD Yoran recruited his successor Nick Samuel, who led 2002's £30m MBO in partnership with institutional investors Barclays Private Equity. The management retained a 20% stake while Barclays took an 80% stake.

The driver behind their choice was the same – they wanted to realise maximum value but put staff loyalty first.

"The family wanted to retire, but knew they wanted to sell to the management to provide continuity and to reward them for getting the business to where it was," Samuel tells Families in Business. I'm sure they would have examined a trade sale and other possibilities, but there was a sense that they wanted to remain loyal to the management and staff, if there was a way to achieve the same value."

Hobbs undoubtedly benefited from the move, reporting a 31% increase in turnover, an 89% upturn in operating profit and 93% increase in pre-tax profit for 2003.

Working with corporate financiers is another sore spot for many families, but an increasing trend driven by the cost of bank lending and the hostility of the IPO environment.

Venture capitalists, private equity firms and other large capital providers are common players in the MBO market, and it is generally accepted that they will want a certain level of control post-deal to ensure the realisation of their projected returns. This is where the exit of the family become clear – but usually to the benefit of the company.

"The fact is, Hobbs is run to a very different culture now," say Samuel. "The business wasn't run formally before – decisions made around the kitchen table on a Saturday morning by the family were as valid as the ones made by them and the management in our offices.

"What we have now is a culture of responsibility from the top to the bottom of the company; everyone has targets, performance indicators, clear and transparent goals and rewards for achieving them. The family, of course, did not need to squeeze every last drop of profit from the company, having created something from nothing in the space of two decades and exited with proceeds of some £30m," adds Samuel. "But I think the way we do things now makes us more efficient because it gives staff the tools to make full use of our products."

As the majority shareholder, Barclays has a non-executive director on the Hobbs board who attends all meetings and communicates with Samuel on a weekly basis. "His role is really to measure with us how well we're doing against our original plan, but it is fairly hands-off," Samuel adds.

With his family business member hat on, Baxi's Erdal is critical of the MBO route for its reliance on outside capital. "You condemn the employees in an MBO to years of uncertainty and enormous pressure, because venture capitalists are in it entirely for their own financial gain in a very short timeframe," he says.

"In an EBO everyone has an interest in building the company at an achievable rate, and the view is short-, medium- and long-term. When venture capitalists or private equity houses say they'll invest in the long-term, my advice is don't believe them."

3i's Lyon tempers the point. "Any investor will have a timescale in mind, usually between three to 20 years, to realise their investment.

"But all players – family, management and venture capitalists – are focused on that goal."  

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