Posted: February 05, 2010
Succession in a Recession
Downturn has slowed sales to third parties, but a revenue dip could be a family value for company heirsBy Mike Taylor
Competition Headwear clan: owner Larry Polner and wife June, along with children Michael and Rachel
Editor's note: see the complete list of Top 50 Family-Owned Businesses here.
On April 25, 2006, Michael Van Gilder took over as CEO of Van Gilder Insurance Corp. In doing so, he succeeded his father, who succeeded Michael's grandfather, who succeeded Michael's great-grandfather, who started the Denver firm back in 1905.
Michael Van Gilder, 42, has seen the studies and appreciates how rare this is. Fewer than 30 percent of family businesses make it to the second generation, and only 10 percent survive to the third, according to Family Business magazine. The ColoradoBiz Top 50 Family-Owned Companies list is exceptional in that regard, as nearly a quarter of the firms (12) have made it to a third generation, and six - including Van Gilder Insurance Corp. - are into their fourth-generation.
Ned Minor, a longtime Denver transaction attorney in the field of mergers and acquisitions and author of the book, "Deciding to Sell Your Business: The Key to Wealth and Freedom," cites a survey by Mass Mutual in which 80 percent of business owners said they wanted to ultimately sell or transfer their business to key employees or family members.
The same survey, he says, showed that happens less than 20 percent of the time.
"Why? Because for the vast majority of business owners, their business is their largest asset," Brown says, "and it's only when they sell that asset and trigger a liquidity event and go from paper wealth to cash do they really achieve their definition of wealth and financial independence."
While the recession has had the predictable effect of slowing sales of businesses to third parties as lowered valuations have made selling an unappealing option for owners, the same downturn has made this an advantageous time for transferring ownership shares within families.
"Two factors are converging in this market to create a tax-planning opportunity and a transition opportunity for family-owned businesses," says Tony King, also with Minor & Brown P.C., where he is a partner. "When the value of the business is down, you have an opportunity to transfer more value to a daughter or a son or a family member. Second, the tax law - at least for now - allows you to take discounts on interest transferred to family members. So that represents more value that you can transfer to a family member without paying taxes on it."
Still, there's one other obstacle to turning over a business to the next generation: The would-be successor - "Junior," as Ned Minor calls the would-be heir - isn't so keen on taking over the business. Especially after he or she often has grown up watching mom or dad toil so hard to sustain that business.
Terry Drahota launched the general contracting firm Drahota Commercial LLC in Fort Collins 37 years ago and has grown its annual revenues to $70 million. Now 62, he says the future of his company "is something that is always on my mind." He accepts that the company's future might not rest with his two sons, one of whom is a 24-year-old professional golfer with eyes on making the PGA tour, the other a 21-year-old junior at the University of Northern Colorado.
"I don't know how much interest there is in the family, to be honest with you," Drahota says. "I would say not very much."
Commercial real estate has taken a horrific beating of late - Drahota says his revenues were down 50 percent in 2009 - making this an inopportune time to think much about selling.
"The most logical way for a business transition seems to be through employee participation in the purchase," Drahota says. "That's something I will be investigating. Right now, just the way the economy's going, I'm really concentrating on other things besides the succession plan."
When that ownership transition does occur, Drahota is concerned that the reputation he's spent 37 years building remains intact.
"My name will always be on the door," he says. "So the logical thing to do whenever we find a purchaser is probably for me to stay involved as a consultant and maybe continue a little marketing until I totally phase out. I'm really concerned about that."
Laurence Polner, 64, has spent the past 18 years building Marner Inc., a manufacturer and embroiderer of baseball-style caps for corporations and for big events like 2004 and 2008 Democratic and Republican national conventions.
Also in the family business are Polner's wife, June, their daughter, Rachel, 31; and on a part-time basis during the summer, their son, Michael, 22, a business and marketing major at the CU-Boulder Leeds School of Business.
"The plan would clearly be to keep the business running," Polner says of his hopes for the family company. Talk of succession plans leads him to recall the summer of 2008, when he put his son to work - selling.
"He'd never sold before," Polner says. "He did actually fairly well. He contacted a number of high-profile customers, and he got some orders, which was really quite exciting." But while Polner says his daughter has shown she can handle any aspect of the business when he takes time off, he doesn't expect his son to join the company immediately.
"I think right out of school he'd like to get a job with another company, get some experience under his belt," Polner says. "But I would think down the road ... very often people don't want to go into the family business in the beginning. They go out and get some experience, and then they decide later to come back into the family business and keep it going."
Marner Inc., which does business as Competition Headwear, is one of the few left in the embroidered-cap industry whose goods are 100 percent U.S.-made. Polner has increasingly used that as a selling point, targeting the military and corporations that tout their allegiance to the U.S. work force. His average orders are for 300 to 500 custom-embroidered hats, but they've been as large as 100,000 and more.
Polner felt the wrath of the dot-com bust back in 2000 when his biggest client went bankrupt before paying him, forcing Polner himself to file for bankruptcy, from which he emerged three years later.
During that time he couldn't get a bank loan, so he built the company back up and doubled revenues within a few years with what he describes as deft use of credit cards. It would seem that experience would serve him well in the current economic climate in which business loans have again become hard to come by. Perhaps there's something to that, but Polner says these conditions are much worse.
"In 2009, it's been much, much broader," he says. "Everybody has just cut back from the sales side. Every one of our customers has been affected. They're all down. In 2000, you had the dot-com (bust), but it wasn't across the whole board."
Kevin Lombardo, who heads up the management-services arm of Denver-based General Capital Partners, which specializes in the sale of distressed businesses, says he's seen an increase in the need for companies to potentially sell part or all of their business.
"In reality today, although all the signs in the economy are partially up, traditional banks still aren't lending money," Lombardo says. "And if they are, they're not lending it to small, family-run businesses. So we are seeing an uptick of those types of businesses that have to potentially sell all or part of the business. And that creates some stress. When you're working with those type of folks, in addition to being their financial adviser, you're also their psychiatrist at times and support function at times, because it's very stressful."
Lombardo says he sees signs that the economy is improving, but his optimism could be described as guarded at best. "When I say the economy's got some signs that are pointing to life, it's in the Dow, it's in the S&P, it's not on Main Street yet," he says. "You're not going to see job creation until at least the second half of 2010, possibly not until 2011."
Lombardo says the solution for a distressed business isn't always about selling or finding financing but about helping owners identify their core competencies similar to the way Competition Headwear's Polner identified and stepped up emphasis of his products' made-in-the-USA selling point.
"Companies can look at what their core competencies are and try to figure out how they can change their business model to take advantage of the opportunities that are going to be out there," Lombardo says. "In any recession there are new industries born, there's new companies born, and they're all going to need products and services. And if a company can take a look at what they're doing and morph themselves, there may be a way for them to survive this."
Mai Tran and Bruce Hottman, both in their 40s, weren't dealing with a distressed business or advancing age when they enlisted a business broker about a year and a half ago to look into finding a buyer for Information Technology Experts. They had founded the Fort Collins-based family company 13 years earlier, with just the two of them as employees and $4,000 in startup capital. By 2008 it had grown to 140 employees with annual revenues of $15 million.
"Our strategy was that when we needed help to grow the company, we would reach out to a larger company to do that," says Tran, 46. Ultimately that help came from Cherokee Nation Businesses of Tulsa, Okla., which wanted to get into the IT space and appreciated ITX's reputation and experience in federal work. The fact that Cherokee Nation Businesses also wanted to retain Tran, Hottman and the Fort Collins employee base also made the acquisition a fit.
"It was really more about the state of the business and for us to be able to continue to grow at the rate we were growing and provide great opportunity for our employees," Hottman says. "We felt we needed a little extra infrastructure in place. Cherokee Nation provided that mechanism."
In selling their business as 40-somethings, Tran and Hottman also fell into alignment with a surprising statistic that attorney and author Ned Minor likes to cite - that 45 is the average age at which most entrepreneurs sell.
"Most business owners think they'll be in their 60s before they sell their business," Minor says. "I've got 35 years of experience that tells me if a guy gets to his 60s and the longer he waits, each year it becomes more and more difficult to sell and pull the trigger. The longer they hang on, the harder it is to let go."
Mike Taylor is the managing editor of ColoradoBiz. He writes about small-business money issues and how startups are launched. E-mail him at email@example.com.