Many family firms lack heirs. Unrelated help is at hand


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Hand coming back transitioning a family business to the next generation can be a dramatic process. If the company is large and the descendants abundant, the intrigue is followed with zeal by both the financial press and the tabloids. When Frédéric Arnault, 29 years old, the second youngest of the five descendants of LVMH luxury empire, resumed its watchmaking activity at the start of the year, speculation was rife about the succession plan put in place by its billionaire father, Bernard Arnault. However, more and more heads of family businesses are faced with the opposite situation: they have no heirs.

Legions of entrepreneurs born in rich countries during the two decades of the baby boom that began in the 1940s are near or past retirement age. Some, like Giorgio Armani, the 89-year-old founder of the Italian fashion house, do not have children. Others have children who want to chart their own career paths. Dalian Wanda, a sprawling Hong Kong conglomerate, faced a public headache when it emerged that the founder's only son, Wang Jianlin, would not take over the company.

Most businesses without heirs aren't as big or as well-known. But there are many of them. Owners aged 65 or older run 23% of U.S. businesses with at least one employee, up from 20% in 2017. The share of German business owners over 60 is 31%, three times the figure of 'twenty years ago. Only one in ten people is under 40 years old. By 2025, nearly 2.5 million small and medium-sized businesses in Japan will have owners aged 70 or older, estimates the country's Ministry of Economy. Half of this group has no plans for a transfer of power.

No owner likes to see their life's work fall into disuse. When otherwise successful businesses disappear without a new owner or are sold off piece by piece by their heirs, they also lose valuable know-how and intangible assets. Collectively, their disappearance into oblivion could constitute a brake on the productive potential of the economy as a whole. Fortunately for landlords and governments, help is at hand thanks to a rapidly growing industry of pseudo-heirs.

The most established group of funders, called search funds, is an offshoot of the U.S. private equity industry. The first such fund was created in 1984 by a professor at Stanford University's Graduate School of Business (GSB). Many are led by one or two MBAs in their early 30s—GSB graduates were historically particularly numerous. They raise capital from outside investors, identify a small or medium-sized business, typically worth less than $10 million, buy it from its owners and take over running it full time.

Research funds are now appearing across the Atlantic, where Europe's aging economies offer rich choices. Arturo Alvarez, founder of a Spanish research fund, says he has studied 3,000 companies in Spain and Portugal over the past two years and has spoken to around 400 companies, from which he will choose just one. Jürgen Rilling, an investor in Munich research funds, notes that many of the more than 500,000 small and medium-sized companies in Germany's formidable Mittelstand with an annual turnover of between 2 and 50 million euros are run by old people who might prefer to enjoy the Majorcan sun.

The next target could be Japan. In the past, some Japanese founders without a male heir relied on the practice of adult adoption: a loyal son-in-law or employee can become the legal descendant of a business owner, thereby avoiding gift taxes. Nowadays, adopted girls are also acceptable. But relentless demographic trends make this adoption even more difficult. Japanese people aged 70, numbering 16.4 million, outnumber those aged 20 by four to three.

Strangely, the world's most demographically challenged major economy has so far not attracted much research funding. However, certain types of entrepreneurs are taking advantage of the demographic cliff in another way. M&A Research Institute, established in 2018 and listed in Tokyo in June 2022, is an estate broker. It uses intelligent machine learning algorithms to match buyers, primarily private equity firms or large Japanese corporations, with sellers. Two-thirds of its target companies are worth less than $3.5 million. Company founder Sagami Shunsaku, 32, says about four in five owners he meets want to sell because they have no other succession plan. Some are over 90 years old.

The pseudo-heir industry is still tiny. Between 1986 and 2021, search funds have completed deals worth a total of just $2.3 billion. But they are growing in popularity: a third of that amount was invested in 2020 and 2021 alone, and slightly more has almost certainly been deployed since.

And they are doing a booming business. According to a GSB study, the typical research fund benefits from an annual internal rate of return (SORTING) — the private equity industry's preferred performance metric, which calculates return on capital deployed but ignores any uninvested money — by 35%. In comparison, conventional private equity funds generated SORTING by around 15% over the past two decades. Jan Simon of IESÉ A Spanish business school (and search fund investor) says the outsized returns are due to a combination of weak competition from larger private equity firms, which prefer much larger deals, and strong involvement of young managing partners.

THE M&A The research institute is just as lucrative. Its operating profit more than doubled in the last fiscal year, to $32 million. Its stock price has increased more than 450% since its listing; Last month, Mr. Sagami's stake made him Japan's youngest billionaire. He is already interested in other parts of Asia that are aging rapidly, such as Singapore.

Correction (January 20, 2024): This article has been updated to correct the name of Jürgen Rilling. Sorry.

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