The trend in the market right now is that the baby boomers who are the largest segment of the population are reaching retirement. These are the people that have built companies and built great businesses. Now reaching a point in their lives where they have achieved a level of success and they want to take a step back from the business. They are trying to figure out how to do that because the business has really served the purpose of providing them income over the past 15, 20, 30, 40 years. That has been the primary means of income for their family. Now they recognize that they’ve got all their net worth tied up in these businesses. For estate planning purposes and various other reasons they need to diversify their net worth out of the single company. To accomplish that, there has to be a liquidity event. Money to facility the liquidity has to come from somewhere.
They can always sell the business to their kids or their employees, and take a seller's note but that doesn’t provide them any actual money. That is just a synthetic transaction and the vendor is still only getting money out on an annual basis from repayment and income on the note. If they want an actual liquidity event, they have to bring in an outside investor. That is where the private equity groups are, by far and away, the best solution for the business owner who is looking for liquidity event.
What we are seeing more and more of is the business owner is the first generation. They've started the company, grown it, and have someone in mind to take over that business. Often times, that’s a member of their family, one of their children. Sometimes it’s not their family because their children are doctors, chefs, or different things. Sometimes, it is a key manager or a couple of key managers within the business that they’ve groomed to take over.
Those transactions are known as a management buyout or if family is involved, we call it family succession type deals where a private equity group is backing a family member or a very close business associate to buy the business from the original entrepreneur who is transitioning out. So it’s a very friendly transaction and often times, a father isn't going to negotiate really hard with his son or daughter. There’s just a way that you handle, approach and facilitate those transactions. The familial dynamics vary differently than if you were just participating in competitive auction processes. We specialize in these types of transactions at KLH Capital. It is important to manage the relationships, respect the culture, and ensure that the goals and objectives of the retiring business owner are in alignment. We have been able to work well with the management team or son or daughter that’s going to be taking the business over.
The selling business owners often looks at this situation where they need a liquidity event but they are not about to turn around and ask their kids to mortgage their future, put their houses on the line and do all that kind of stuff just so the patriarch can have a liquidity event. Without a new sufficient investor coming in, anybody putting debt on the company is going to require personal guarantees from the management team and the people taking over. It’s hard for the father who is selling the business to his son to look his son’s wife in the eye at Christmas having just asked her and her husband to personally guarantee $5 million or $10 million worth of debt. It creates a really awkward family dynamics and that’s where private equity can help alleviate a lot of that.