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Business Bloodlines Die Out as Asian Owners Opt for Buyouts

Yoojung Lee and Shiho Takezawa

(Bloomberg) -- After 37 years of running his business, Shigeru Nagatomi handed over the keys in December last year. Nagatomi Pharmacy Corp., the medical-supplies shop that bears his family name, had grown to 23 dispensing pharmacies in Oita, a coastal prefecture on Japan’s Kyushu Island known for its hot springs.

Nagatomi had contemplated passing the business onto his son, a licensed pharmacist in his late 30s, but a sale seemed a better option considering the need to update IT systems and attract talent. Sapporo-based Medical System Network Co. paid about 3.2 billion yen ($30 million) cash.

“Of course I felt sad,” Nagatomi, 67, said. “But without enough money, pharmacies can’t catch up with technological innovation. It was really a hard decision.”

In Japan and South Korea, Nagatomi’s story is increasingly common. Aging company founders are opting for buyouts rather than keeping the business in the family. The reasons vary, but in many cases, succession is a dominant factor. 

Around 66% of small- and medium-sized businesses in Japan lack successors, according to Jun Tsusaka, the chief executive officer of Nippon Sangyo Suishin Kiko Ltd., a private-equity firm based in Tokyo. Yet, when it comes to selling their companies, founders want a buyer who will keep the business intact, and pursue growth. Private equity, with $1.26 trillion of dry powder to invest globally, often fits that bill.

“When they sell to private equity, the legacy of the business goes on,” said Tsusaka, who used to be head of Japan for TPG Capital LP.

Tsusaka formed NSSK in 2014 with other ex-TPG employees after seeing the rise of succession-driven transactions. He felt there would be greater opportunities in the middle market rather than going after traditional large-cap companies.

For family founders, selling out to private equity also immediately creates “cash-rich individuals,” he said.“They were paper rich before, and all of a sudden, they become actually cash rich,” Tsusaka said.

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Almost all NSSK’s investments to date have involved family owners with succession woes. In 2017, it bought out Bunkasha Publishing Co., a distributor of Japanese manga comics. The owner, who doesn’t want his name disclosed, had no heir and was keen to find someone who would continue to build and grow the 70-year-old business in a digital environment.

According to Shintaro Omori, the current CEO of Bunkasha, the owner chose NSSK mainly because of its understanding of the company’s needs and deep pockets. The transaction amount wasn’t disclosed but most NSSK deals are between $100 million to $200 million.

Deals that line the pockets of founders and fit a new investor’s growth profile are erasing the perception of private-equity firms as vulture funds that only prey on weak companies. They’re also becoming a popular choice for family businesses South Korea, where similar demographics exist.

A South Korean government report released in March found that more than 84% of mid-sized companies don’t intend on passing the business to the next generation. Tax is a big reason. It’s not uncommon for business owners in both countries to be subject to hefty charges. Korea’s inheritance tax of 50% is the second highest among OECD nations, after Japan’s 55%.

Koo Kwang-mo, the chairman of LG Group -- one of South Korea’s largest conglomerates -- made headlines last year after he faced an inheritance tax bill of more than $630 million following the death of his father. That was enough to strip Koo of his billionaire status.

Nagatomi said he used to worry about inheritance tax also. He doesn’t any more “because we earned money from selling the company.”

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As more and more family owners give up on plans to have blood relatives inherit their business, South Korea’s private equity market has seen a ramp-up in buyouts. Buyout funds accounted for 41% of new capital pools raised in 2018 versus 8% in 2012, according to research firm Preqin. 

In January, Hong Sang-wuk, the founder of Hong International Corp., sold his company to mid-cap buyout specialists Orchestra Private Equity in a deal worth around $103 million. Hong founded the Seoul-based maker of electronic dart machines in 1999. He wanted to try his hand at something different but with a son who was just 7, didn’t have any suitable family members. 

“Succession issues were the key reason why he sold the company,” said Jay Kim, a managing partner at Orchestra. “He seemed to think that our offer to help him cash out and facilitate further growth was attractive.” Kim, who started Orchestra in 2014 after more than a decade working at firms including Bain & Co., said he’s seen numerous mid-sized firms grapple with succession issues. Orchestra scours the middle market for such companies, looking particularly for those with untapped geographic-expansion potential. The private-equity firm now plans to increase Hong International’s presence in Europe and the U.S. 

The surge in families with succession troubles has also proved a boon for M&A matchmakers like Nihon M&A Center Inc., which connected Nagatomi with Medical System Network. Nihon M&A has seen a more than three-fold increase in business over the past five years, closing 770 deals in 2018. More than 80% are succession related.

“I meet many family owners through various opportunities,” Orchestra’s Kim said. “Even those I know have recently started asking me questions, like how much would their company be worth. They feel they’ve reached their limit.”

To contact the reporters on this story: Yoojung Lee in Singapore at ylee504@bloomberg.net;Shiho Takezawa in Tokyo at stakezawa2@bloomberg.net

To contact the editors responsible for this story: Pierre Paulden at ppaulden@bloomberg.net, Katrina Nicholas

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