The Struggles of a Family Business
FAMILY BUSINESS: CASE NUMBER FOURTEEN, THE CHANDLER FAMILY
THE STRUGGLES OF A FAMILY BUSINESS
Nathan Chandler had been in the retail sporting goods business his whole life in Hingham, Massachusetts. His father William started the business called Chandlers, selling mostly hockey and baseball equipment. Over the years the store continued to expand in its original location. Nathan, an only child, joined his father when he finished high school. Nathan was aggressive and wanted to add more products to offer to their loyal customers. First they added fishing equipment, both fresh and saltwater gear, and related clothing items. Then they added hiking and hunting equipment and related clothing. Nathan knew what his customers liked to do in their recreational time and he intended to match their interests. It was not lost on Nathan that the profit margins on fishing, hiking, and hunting items were at least 20% better than on baseball and hockey equipment.
Their location was perfect. The store was easily accessible by the families traveling to and from Cape Cod on Route 3. It seemed that everyone in the suburbs of Boston knew of the store and its quality products. The multiple parking lots were always full and on weekends the family had to hire off duty police to help manage the traffic. The store was open 365 days a year from 8:00 AM to 10:00 PM. The purchasing manager was known for his high product standards and for the rigorous testing of products that the manufacturers tried to sell to the store. In a nearby location, the store had a ‘testing’ facility where clothing items were put into commercial washing machines and run through many times to see if a product held up. In most cases, manufacturers were required to label clothing with the store’s label, Chandlers. By 1980, Chandlers employed over 150 people. Their training program was designed to teach staff great customer service. Their floor salespeople were chosen for their knowledge of the products they sold in their department. Fishing items were sold by fishermen and hockey equipment was sold by hockey players, including two retired Bruins players.
In June of 1989, Nathan, age 50, and his father William, age 72, were in a car accident on Rt. 95 while returning from a buying trip to New York. William died instantly while Nathan languished at Mass General Hospital for nine months in a coma before passing away. Nathan was survived by his wife Carol and one son, Norman, who was 19 and about to enter Northeastern University in Boston. William’s wife had died many years before of breast cancer.
The store had quality professional advisors who helped guide the Chandler Family and business during this difficult time. Nathan’s best friend Eric, was an insurance professional. Prior to his death, Nathan sought out Eric’s advice and purchased life insurance for himself and Carol, and for the key people in the business. The business received $5 million of life insurance proceeds on Nathan’s life and Nathan’s family received another $5 million. This liquidity gave the business time to transition its leadership and allowed Carol the peace of mind that she could handle the family financial responsibilities. No estate taxes were owed, as Nathan left all his assets including his Chandlers stock (some gifted to him over the years by his father and the rest inherited from his father who died first in the accident) to his wife Carol. The estate tax marital deduction worked to preclude an estate tax at Nathan’s death, but leaving all the substantial assets to Carol would be a problem for her estate. Nathan had been planning to revise his estate planning documents when he turned 55, even though Eric kept saying to him that he should not wait as the value of the business was increasing every year.
Norman felt lost. The numb feeling right after the accident and the horror of thinking about losing both his dad and his grandfather produced various emotions. At his father’s funeral he sat with his family and left the church as they did, actually following a little behind. In the foyer of the church, friends and relatives gathered around his his mother expressing their sympathy while Norman was left standing alone at the edge of the room with his back to the wall not knowing what to do. He felt alone and tears welled up in his eyes. Eric came over to him, putting his arm around Norman’s shoulder, saying that he understood this difficult time as Eric’s own dad had died when he was 15. Norm felt comforted by Eric’s presence. Eric told Norm that his mother had invited him, the family and friends to her home following the burial and suggested that Norm ride with him. Eric left for a moment to whisper to Carol that he would take Norm to the cemetery and then to her home. She was grateful that someone was watching out for Norm as she was overwhelmed herself.
Eric talked the whole way to the cemetery located near the Hingham Yacht Club about his experiences with Norm’s father. He talked about their hunting trips to Lovell, Maine where both families had cabins on Horseshoe Pond and their fishing trips to northern Maine and Canada. Norm had gone fishing and hunting with them a couple of times and always had a great time. Eric was a lot more outgoing than his dad and always had stories to tell about his family and his experiences. Some were hard to believe and Norm once asked his father if Eric’s stories were true and got the response “of course,” but the smirk on his face in saying this made Norm always wonder.
Three weeks later on a hot July evening, Norm was having dinner with his mother when the phone rang. Eric was on the line and asked to speak with Norm’s mother. Eric wanted to know if he could ask Norman to go fishing with him in Canada the next week as Eric’s wife who was planning to go sprained her ankle playing tennis. Carol thought that was great and so did Norman. He joked with his mother that he knew where to find the equipment he would need. That made Carol pause and she left the table and came back with two of her husband’s favorite Orvis fly rods, a six weight, and an eight weight. She knew the lake trout, northern pike, and salmon were large in Quebec and that rods larger than those used in northern American states would be needed. Norm at first felt awkward about using his father’s fishing equipment, but Carol said his dad would be pleased for him to do so.
Norm was excited about the fishing trip and waited outside with his backpack, fishing rods, and duffle bag when Eric arrived. They drove to Quebec City, staying overnight at the Château Frontenac. Norm had never been there before but knew that his dad and Eric always stayed there on the way to northern Quebec saying that they had to start “roughing it” before getting to the fishing camp. The Chateau was a four diamond property owned by the Canadian National Railroad so the “roughing it” was just a joke. Dinner at the Continental Restaurant across the street was not roughing it either as they had a magnificent meal. The next morning they took a cab to the railroad station, leaving the car at the hotel. The train took them to the small town of Schefferville where they were met by the guides who would be with them for the next week. It took two hours by jeep to get to the lake’s edge and another half hour by boat to get to the fishing lodge. They were met there at the dock as planned by two of Norm’s friends from Maine, David Reed and Gary Hart. Eric explained to Norm that he and Norm’s father met David and Gary many years before while hunting at Joe McKeen Hill in Lovell.
David and Gary were dragging a large buck out of a rutted logging road when Eric and Nathan came along. David and Gary were struggling so Eric and Nathan helped them get the deer to their car and all four men rested and had lunch. It was odd that all four men had packed tuna fish sandwiches, chips and diet coke. Eric remembered that David, who grew up in Lovell, was wearing sneakers and a green and black hunting jacket covered of course with a fluorescent orange vest. When Eric told this story to Norm, he also said that over the years when hunting with David he never saw him wear anything but those sneakers even though Nathan had offered a free pair of Chandler’s best hunting boots.
In the next few days, Norm caught more fish than the rest of the group. Everyone joked that it was because Norm had the best guide, a French Canadian named Willie, who spoke little English and only had one eye. He did, however, know where to find the best fishing spots. It was a great week. The older men enjoyed having Norm with them and commented to themselves how much like his father he was. Norm liked hearing their stories about their personal and business experiences.
Norm learned that David was a family business consultant and tax guy who had helped many families in New England, sometimes working with Eric. Gary was a prep school English teacher and could tell even more stories than Eric. David and Gary had known each other since they were freshmen together at Gould Academy in Bethel, Maine.
After the trip, Norman went back to work in the store. That summer he was working in the purchasing department learning how to judge the quality of clothing and equipment being offered by vendors and how to negotiate the best prices.
Over the next six years, Norman graduated from Northeastern in the class of 1995 and went to work full time in the store. His mother, the sole shareholder, had brought in a CEO with retail sporting goods experience and the store was doing very well under his leadership. Norman was asked to join the Board of Directors when he graduated and was brought onto the management team. That team consisted of ten individuals with the diverse talent that it took to operate a $100 million retail business. Much of the recent board discussion was devoted to strategically planning for the future. The store’s profits were fine, but were not increasing as they had in past years. The retail traffic was stable but the catalogue sales were diminishing. Their competitors were growing by adding new locations and using the internet to produce sales. The decision was made that the Chandlers needed to consider doing something to grow; open new locations; develop an internet strategy, or acquire another similar business which already had multiple retail locations and an internet sales presence. They even discussed selling the business, as one outside director stated that Chandlers may have reached its peak and any growth strategy would bear more risk than the Chandler family might want.
The board room discussions generated even more conversations between Norman and his mother. Norman had moved after his graduation to a small condominium that he purchased with his graduation money and a modest bank loan. Carol had started dating a year after Norman moved out of the family home and it terrified Norman. To him, this was his dad’s wife and some emotional part of him rebelled at seeing his mother with another man, no matter how nice the guy was or how respectful he was of Norman. Norman realized that he better get used to the idea that she might marry again. He did not know what her plans for the business were. Her trusts from Nathan’s estate owned 100% of Chandlers. Norman wondered and worried what would happen to that ownership if his mom remarried. His only work experience was with Chandlers and he had always assumed it would be his life’s work. Now he wondered if his world might be turned upside down.
He worried and watched as Mom increased her social life. She had never spent much time in the store but had been a member of the board for a long time. She was intelligent and did not hesitate to express her opinions, especially now. One Saturday morning over coffee at the Hingham Yacht Club, Carol told Norman that she was worried about Chandler’s future and wanted to know what Norman thought about the board’s suggestion that they engage in a growth strategy. She said his thoughts were crucial as he would eventually be the sole owner of the business. Those words at first lifted some of the anxiety Norman was feeling, but now he was being asked to help make a significant decision causing a new level of anxiety.
Norman said that he had learned in an entrepreneurship class at Northeastern that astute business owners, when faced with a difficult decision, often looked for professional guidance. He suggested that he and his mother call David Reed who was a good friend of the family and a well- known New England family business consultant. Carol agreed and suggested that they ask Eric to also meet with them. Carol asked Norman to make the calls.
Norman called Eric and told him what he and his mother were concerned about. He asked if Eric would help them as a long-time friend of the family. Norman also asked if David Reed was a good choice as a consultant. Eric agreed to meet and confirmed that David was a great choice.
David was pleased to receive Norman’s call asking for a meeting, but also realized that this would not be an easy assignment. Prior to the scheduled meeting David sent Norman a list of information he wanted to review before the meeting so that he could do ‘his homework.’ He asked for the latest financial statements and tax returns for Chandlers, the budget for the next year, a copy of the business valuation done for Nathan’s estate, a copy of the trusts which held the Chandlers’ stock, the minutes of the last few board meetings, a copy of Chandler’s Bylaws, and a list with resumes of the key members of the management team.
David’s homework revealed that Chandlers, an S Corp., was, as he suspected, quite successful with a little over $100 million in sales and $12 million in EBITDA, which was quite good for a retail operation. The balance sheet included $8 million in cash, including the life insurance proceeds, and a line of credit with a $500,000 balance outstanding secured by the inventory of $25 million. The Chandlers stock was valued at $75 million in Nathan’s estate or about six times EBITDA.
The minutes of the Board meetings did not hold much relevant information, but David did notice that one of the board members brought up the name of an investment banking firm as part of the discussion of what to do with the business. It was interesting to David that the only member of the management team to attend or report to the board was the CEO. He made a note to ask about the senior financial officer.
David and Eric met with Carol and Norman at Carol’s home the next week. Carol and Norman had decided this initial meeting should focus on the family and ownership issues and the board would not be informed of the meeting, at least, not until Carol and Norman were ready.
Carol let Norman outline their concerns. He articulately described the business, its place in the industry, its slowly reducing sales and margins at a time when competitors were increasing their sales, and the push by the CEO and some of the Board members to develop and execute a growth strategy. Norman explained that the options discussed were to open additional retail locations, invest in an expanded website with internet sales capability, add more product lines or even sell the business. Eric and David asked many questions. They first wanted to know if any of these options had been researched by the management team and if a business plan complete with financial projections had been prepared to help analyze the potential risk and rewards. Norman said that no plans had been prepared as the CEO wanted some direction from the board before investigating and developing a strategy. The Board in turn had looked to Carol and Norman for guidance.
David then asked Carol and Norman a key question: “What would you like to do?” Carol said that she had no personal interest in being more active in the business and saw it really as a life decision for Norman. She went on to say that her husband assumed that the business would be carried on by Norman but mentioned a couple of times that he wanted Norman to be his own person and that he knew that children often did not share their parents’ dreams. Norman felt the pressure of the moment and his mother’s comments. He was not sure what to say, so simply said he really did not know what to do. He said he had never had a business experience other than Chandlers and even did his Northeastern Co-op assignments at Chandlers.
David suggested that Carol and Norman ask the CEO to develop a strategy addressing the options of new locations and an internet sales activity. In a conference call meeting, the Board agreed to ask the CEO to prepare a written plan for adding 3 more retail locations over the next three years, including in the analysis defining the resources needed to do so such as labor and capital; determining how to select the locations and outlining a marketing strategy. David suggested that the CEO should be given a $100,000 planning budget with the goal of a providing a preliminary plan within 60 days. David further suggested that an internet consulting firm with experience in developing sophisticated retail merchandise websites be retained to outline what the Chandlers should do to enter the internet sales world; what it would cost and what operational changes Chandlers would have to make, if any. Norman was quick to note that Chandlers already had a state of the art shipping department due to its existing large catalog business.
Carol said that a Board meeting was scheduled in two days and the assignments would be made. She then suggested that David and Eric take Norman out to lunch to talk further. She knew all this was a lot for Norman to deal with, but she was happy about how well he handled himself that morning. She knew that his father would be proud no matter what decisions were made.
Eric suggested going into Boston to the Harvard Club where they could have a private room and talk as freely and for as long as they wished. Eric lived in Hingham so he drove to Commonwealth Avenue by himself and Norman rode with David as David would go back to Maine after lunch. Eric also wanted David to have some private time with Norman.
During the ride Norman mentioned that he was seriously dating a girl named Sally who he met skiing at the Killington Ski Resort in Vermont a year ago. She was a marketing professional at Ben and Jerry’s in Stowe, Vermont. Norman said that he went to Vermont on most weekends or Sally would come to Hingham. He smiled when he said he sometimes ‘stretched’ his buying trips to find clothing manufacturers in Vermont, scheduling such meetings on Fridays or Mondays. David smiled too, thinking back to his own dating world of many years before. Sally was an outdoor person, a great skier, a mountain climber, and a runner. Norman said that Carol had not yet met Sally, but that would need to change soon. Norman mentioned that Sally had been talking about going into the Peace Corp., an interest that developed while talking with her socially conscience colleagues at Ben and Jerry’s.
By the time they got to the Harvard Club David had developed a feeling that Norman was looking to his personal future and was almost as confused about that as he was about the strategic direction for Chandlers. This was certainly not unusual for a guy in his late 20’s.
Eric was already at the club and had secured a private room. It was a relaxed atmosphere and the talk was mostly of fishing and mountain climbing in Vermont. Norman told Eric about Sally and Eric got Norman to promise to introduce him to Sally when she next came to Hingham but not before he introduced her to his mother. Eric was smart. Norman paused after dessert and asked if they could talk about the option of selling the business. David answered that of course they could and he saw that as part of his overall assignment, but wanted to be sure the other options were flushed out and put on the table first. Norman said he wanted to know if there was a way the business (or most of it) could be sold and allow him to continue in the business as a part owner. David said most anything was possible and offered to send Norman an article he had written about the role of private equity firms in such situations.
They scheduled to talk again in the next week. The next day David sent Norman and Carol the following article:
PRIVATE EQUITY FIRMS: A SOURCE OF CAPITAL FOR GROWTH AND ACQUISITIONS
Private equity dates back to 1946, with the formation of the first firm that pooled institutional capital to finance investments in private companies. Throughout the 60-year history of the industry, private equity has touched thousands of companies in hundreds of countries around the world, ranging from several hundred thousand dollars to finance small startups, to tens of billions of dollars to finance the largest leveraged buyouts. In general, private investments can be categorized into two types: leveraged buyouts or venture/growth capital, depending on the maturity of the target business. Leveraged buyouts typically utilize a mature business’ stable cash flows as the foundation on which to finance its acquisition, while venture or growth equity investing seeks to provide capital to a business to finance its development to the next phase of its evolution.
Private equity transactions typically involve extensive due diligence conducted by the buyer, ranging broadly from industry growth prospects to customer/supplier interviews to divisional working capital requirements. Each private equity fund conducts it’s investment diligence process uniquely, depending on the fund’s philosophy and investing mandate.
Many of America’s most successful companies have been financed by private equity at some point in their history, including: Apple, Microsoft, Genentech, Amazon, Burger king, Southland Corp, Dominos’ Pizza, Continental Airlines, Safeway, Dunkin Donuts, Snapple, and HCA. As evidenced by the past several decades, private equity has contributed to the growth, development, and even the survival of some of the most famous institutions in the history of corporate America.
By definition, private equity enables companies to access a less scrutinized, less regulated and more ‘patient’ form of capital outside of the rigorous spotlight of the public markets, which constantly demands short term results. This dynamic enables most private equity firms to have a long-term view of value creation, enabling their companies’ management teams to deploy capital more efficiently to expand into new products, facilities and geographies as well as engage in add-on and strategic acquisitions.
By viewing managers as their long-term partners, private equity owners help to eliminate the misalignment of interests that so often exists between owners and managers. This is often implemented through long-term equity incentive programs which transform managers into owners. In most cases, the private equity firms provide managers with financial advice, capital markets, and M&A expertise, new ideas for corporate and business strategy and vetting of existing initiatives, as well as access to a wealth of relationships and market research information. Further, private equity owners work to institute good corporate governance, which leads to management accountability and better decision making without the scrutiny from outsiders. This partnership approach aligns all parties, which allows for more prudent and more effective risk assessment and capital deployment, and therefore enhanced value creation.
UNIQUE INVESTING PHILOSOPHIES –AN EXAMPLE
Each private equity firm has its own unique traits and features, depending on the firm’s investment philosophy and is driven largely by the experience of the firm’s founders.
One well-respected private equity firm has a strong culture of investing in quality businesses for the long-term. This firm seeks to be the ‘investor of choice where relationships matter’ i.e. businesses for the long term held by families or entrepreneurs who seek capital for growth or recapitalizations. As a part of this investment process, it conducts extensive due diligence on companies for which the value proposition is distinct and tangible and can be the subject of rigorous qualitative and quantitative analysis. By having a deeper understanding of the company and its ability to create value, the firm becomes a better partner with management to help grow and develop the business and corporate strategy.
This firm also believes strongly in maximizing operational flexibility for management teams of its portfolio companies. First, this firm employs conservative amounts of leverage and sometimes utilizes all-equity capital structures, to enable its portfolio companies to operate through potential downturns in the environment and maintain flexibility for management to execute its growth plan, whether organic or through acquisitions, without the burden of significant debt. Second, its 20-year investing horizon, twice the industry average, truly merits the definition of long-term, thereby maximizing the flexibility already inherent in the industry. In addition, the firm takes a hands off approach to operating the business by acting primarily as a strategic partner, deploying an ‘industrial’ approach to investing by using its capital and expertise to help build and grow the business. In total, this approach to private equity enables this firm to become a long term partner with management to help create a business that is more strategically important and thus more valuable.
The above brief and general description purposefully touches the surface of a large and complex source of capital. The test of whether and which private equity firm can help in a specific situation requires further investigation and communication.
David and Eric spoke a couple of times before David called Norman the next week. David wanted Eric’s thoughts about the meeting and the comments made by Carol and Nathan. Eric mentioned that he thought Carol’s (romantic) relationship with Roger White was getting serious and he expected that was partly why Carol seemed to be distancing herself from the business decisions. He also suspected she was giving Nathan the lead to help him become the business leader, if he so wished. Eric knew Roger, who was a distinguished businessman in Boston. Roger’s wife died five years before. Roger had a successful career as a senior management person at Gillette, retiring the year before with a healthy pension and even healthier portfolio after cashing in all his stock options. Roger had no children and was said to have received a substantial inheritance from his wealthy wife. Eric liked him.
Eric was not sure what Norman was thinking, but knew that more conversation would be needed to help Norman analyze the business and personal options available to him and Chandlers.
Over the next two months David and Eric met with Carol and Norman several times, sometimes individually. Norman and Carol thanked David for the private equity article but had no other comments. Norman continued to ask good questions and was more than ready when the CEO brought his preliminary analysis of adding 3 more retail locations over the next three years. It would cost more than anyone had expected, close to $10 million per location, even assuming the space would be leased. The majority of the cost was the inventory for the location, the staff to be hired and trained, and the expected losses to be endured before a location would be profitable. The CEO suggested that if the decision to open the first location was made, they should wait on the second location until they were certain that the first location would be successful. The board was pleased with the quality of the analysis and scheduled another board meeting the next week for the presentation by the internet consulting firm.
Nathan called David and Eric the next week after the consulting firm gave its report. The cost of creating an internet sales function was a lot less than opening a new retail location. The consulting firm did, however, alert the board that internet sales would erode the existing catalogue sales, but they were not sure by how much. They did provide projections on the amount of internet sales that could be achieved by having a sophisticated internet presence. They projected that in the first three years internet sales would be 12 to 15% of total sales. The board was pleased and excited by the report, probably as much by the low comparative cost, as the quality of the analysis. Carol interrupted the conversation to say that she and Norman needed to digest these reports and would come back to the board with their thoughts in two weeks. It was odd for Carol to cut off conversation and only the second time she pre-empted a decision as an owner.
A week later, Norman called David and Eric asking to meet at the Harvard Club, where he was now a member having been sponsored by Eric. Norman joked with David on the phone about a Northeastern graduate being a member of the Harvard Club. Norman told David that he and his mother had spoken many times the last few days and a plan was coming together but they needed David and Eric’s guidance.
It was a rainy November day when all gathered at the Club. It proved to be one of the more interesting family business experiences of David Reed’s career. Norman started off by telling Eric and David that Sally had spent the weekend at the Chandler summer house on the Cape with he and his mother. Carol quickly added that Sally was wonderful and she was so pleased to meet her. Norman had made an outline of what he and his mom had discussed and wanted to recommend to the board. Norman noted first that both of them were pleased at the quality of the information their CEO had provided on the option of opening a second retail store. It was also clear to him and Carol that the internet option should be taken immediately, as it presented the best potential reward at the least cost. David and Eric nodded in agreement.
Norman stated that they would recommend to the board that a site location firm be engaged to find an appropriate location in Burlington Vt. for the next retail outlet for Chandlers. Burlington, Norman said, was in the heart of the outdoor living community. Its location abutting Lake Champlain and the Appalachian Mountains made it geographically a natural choice. Also, Burlington was a college town with Champlain College and the University of Vermont located there. College students were a key market for Chandlers. An added advantage was the highway system with Rt. 89, a major thoroughfare, leading to Montreal only an hour or so away.
Norman said he had asked his mother if he could be in charge of the new location starting with the planning and ending with managing the store once it was operational. He was quick to also say they needed to discuss this plan with their CEO, but knew he would agree and offer all the resources of Chandlers to help. Norman had already found that several individuals employed by Chandlers had either grown up in the Burlington area or had gone to school there. They would be logical candidates for a transfer, if they wished. Norman then smiled and said he would also save a lot of time traveling to and from for a special young woman.
David and Eric could only agree. Who could criticize a business venture fueled by romance?
As they were leaving the Club Carol took David and Eric aside and said that she needed their help in restructuring her estate plan, especially the ownership of the Chandler stock.
That task would begin a whole new chapter in the life of the Chandler Family and its business.
TO BE CONTINUED