Neal Rosenthal found a different kind of heir when he set out to craft a succession plan for his wine-importing business a few years ago.
Mr. Rosenthal wasn’t ready to give up the company he started in 1977 out of a liquor store connected to his parents’ pharmacy in New York City, on Manhattan’s Upper East Side, and his daughter wasn’t interested in taking over. So Mr. Rosenthal sold a stake in the business to a buyout firm and stayed on as CEO.
“I am confident that if I dropped dead today, my business would continue on without me,” said Mr. Rosenthal, 76 years old.
Private-equity firms are joining America’s family businesses. The industry that made its name taking private big corporations has shifted its focus to smaller targets, snapping up car washes, pet-food makers and specialized manufacturers, some of which have been family-owned for several generations.
Family businesses hold particular appeal for buyout firms, and they are throwing out the traditional private-equity playbook to attract them. Management is often left intact. Owners keep big stakes. Buyout firms pledge to retain employees and plow more money into the businesses.
Still, some buyout targets end up carrying heavy debt burdens that can turn a once-profitable company into a money-losing one. Families might ultimately cede control when the business is later sold so their private-equity owners can realize gains. Communities and workers, by extension, can lose their personal ties to a company’s ownership.
At the same time, the deals help aging business owners ensure a future for their companies after they are gone. Many are finding that their own children aren’t interested in taking over. Those whose children want to remain involved recognize that their offspring will need additional technological and financial know-how.
Even owners who want to keep working are often looking to untangle some of their wealth from their businesses. They are ready to share the risk they have shouldered alone for years, but they aren’t prepared to cede their legacy to a bigger competitor.
For Mr. Rosenthal, a top concern was preserving his decadeslong relationships with winemakers in Italy, France, Switzerland and Spain.
After reviewing nine bids, including one from a bigger wine company, he and his wife and co-owner, Kerry Madigan, chose to sell a majority stake last year to Pittsburgh private-equity firm Incline Equity Partners.
Since Incline invested, the holding company that owns Rosenthal Wine Merchant has bought one of its distributors and another boutique wine business. Mr. Rosenthal identified both of the targets but said he wouldn’t have approached them without Incline’s backing.
“For 45 years, it’s been our capital at risk,” he said.
Companies in the same or adjacent businesses looking to bulk up had long been seen as the buyers of choice. They could pay more—mergers of like businesses often generate significant cost savings—and quickly grow sales. Lately, though, deal-hungry private-equity firms have been outbidding these strategic buyers, bankers say.
Private-equity firms can pay more when companies they already own do the acquiring, essentially acting as a strategic buyer. Sometimes they buy up numerous companies in the same industry and merge them together.
A family business that hasn’t been touched by private equity or public shareholders can offer a path to the biggest profits because most of the financial or operational levers that could juice returns—making production more efficient, beefing up contracts, merging with competitors or funding expansion into new markets—have yet to be pulled. Many such businesses carry little debt.
Buyouts involving between $50 million and $99 million in equity—the portion of the purchase price that isn’t financed with debt—have had median returns of 25.4% since 2010, compared with 19% for deals $1 billion or higher and 23.4% for all deals, according to DealEdge.
In 2014, some members of the Lang family were approaching retirement and looking to cash out of their 80-year-old pet-food business. L Catterton, a Greenwich, Conn.-based private-equity firm that invests in consumer brands, spotted an opportunity.
Americans’ growing obsession with their pets had recently spurred Ainsworth Pet Nutrition LLC to shift its focus to growing its premium offerings under the Nutrish brand, a partnership with celebrity chef Rachael Ray. L Catterton wanted to bring the brand to the mass market.
But first the firm had to win over the Langs. L Catterton Co-CEO Scott Dahnke trekked to the company’s headquarters in Meadville, Pa., which sits about two hours from a major airport, and was grilled for three hours by four family members and the company’s CFO.
“It was like a political town hall for them where half of the people are progressives and half the people are conservatives,” Mr. Dahnke said. “Somehow I survived that initial meeting.”
The family opted to sell a 42% stake at a $200 million valuation but gave L Catterton free rein to run the company.
Ainsworth paid down debt, expanded its marketing budget and cleaned up its contracts. It broadened its product offerings and moved into new distribution channels. The company acquired Triple T Foods Inc., which had manufactured some of its products. By 2018, annual sales of the Nutrish brand had grown sixfold to $700 million.
When J.M. Smucker Co. bought Ainsworth in 2018 for $1.9 billion, L Catterton and the Lang family earned a whopping eight times their money based on the value of their stakes when the private-equity firm invested.
“It really is the American dream,” said Sean Lang, Ainsworth’s CEO when L Catterton invested.
Buyouts can come at different points in a company’s life cycle. Some involve taking a public company private; others are meant to prepare a private company to go public someday. Private-equity firms often buy companies from each other, each one nipping and tucking and tweaking the business model to extract more profits along the way. Sellers who retain a stake can also reap huge rewards when the business is sold again.
Bill Clendenen sold his Eugene, Ore., workplace safety company to private-equity firm Riverside Co. in 2006. In 2012, Riverside sold Health & Safety Institute Inc. to another firm, DW Healthcare Partners of Toronto, which then sold it back to Riverside in 2015.
In 2019, Riverside sold HSI to Chicago-based Waud Capital LLC. With each subsequent sale, Mr. Clendenen has retained a stake in the company, and each time he has earned more than three times his money.
The company has grown so much that the check Mr. Clendenen received from his less-than-5% stake in the most recent sale to Waud was bigger than what he and his original partner received when they first sold in 2006.
While he no longer works for HSI, Mr. Clendenen still owns a small portion of the company and expects to collect another check when Waud sells it.
“It has transformed my life and my family’s life,” he said. “A lot of people think private equity is there just to slash and burn, but this has been all about growth.”
Buyouts typically increase risk because a significant portion of the purchase price is financed with debt. Scores of private-equity-backed companies have gone bankrupt under the weight of debt loads they couldn’t afford, resulting in the loss of thousands of jobs.
Those risks extend to more workers and communities as private-equity firms buy up more companies, a concern that has led to attempts by lawmakers, including Sen. Elizabeth Warren (D., Mass.), to further regulate the industry.
Private-equity firms and private-equity-backed companies employed 11.7 million workers who earned a total of around $900 billion in annual wages and benefits in 2020, according to a report by consulting firm EY that was commissioned by private-equity industry lobbyist the American Investment Council.
Gary DeAngelo kept a stake when he sold his sunscreen company, Sun & Skin Care Research Inc., to private equity in 2012, but the buyers brought in new management.
The new CEO, who came from a large consumer-packaged goods company, ramped up production with the goal of boosting sales of its No-Ad, Ocean Potion and Bullfrog sunscreens.
The strategy was a flop. Retailers typically buy sunscreen on consignment during the busy summer months and return whatever they don’t sell at the end of the season. The company ended up with a glut of inventory. Profits evaporated and losses mounted, said Warren Feder, the company’s banker at Carl Marks Advisors, which specializes in advising family businesses.
The company got a new CEO who repaired some of the damage, but by 2015 the weight of its roughly $30 million in debt proved too heavy. It was forced to pursue a foreclosure sale that allowed it to avoid bankruptcy and prevented it from missing the all-important summer season. Mr. DeAngelo submitted a bid to buy it back but was unsuccessful. He didn’t respond to requests for comment.
The new owner, private-equity backed Kik Custom Products Inc., closed Sun & Skin Care Research’s Florida factory, putting 130 people out of work.
When John McGaffey decided it was time to sell his company, which makes pedestrian signals to help blind people safely traverse crosswalks, he had a demand: No layoffs.
Mr. McGaffey’s father had founded the business in 1969. With 80 employees, it is among the larger employers in its hometown of Greenville, Texas.
After a process involving 10 bidders, including six private-equity firms, Mr. McGaffey sold a majority stake in Polara Enterprises LLC to Los Angeles-based Vance Street Capital last year. The Vance partners showed up in jeans and polo shirts instead of suits and loafers. They flew commercial. And they agreed not to cut any jobs.
Mr. McGaffey, 64, retired but he kept a seat on Polara’s board. His son and son-in-law, both in their mid 30s, remained executives.
“I would have loved to have just left it with my boys, but we felt that we could get a lot further in terms of our technology if we could get an outside investor,” said Mr. McGaffey, whose voice can be heard at intersections around the country instructing pedestrians when to cross. “I didn’t want to risk all of my own capital.”