Asian business bloodlines on brink as lack of heirs pushes owners into arms of private equity

SINGAPORE – After 37 years in business, Shigeru Nagatomi handed over the keys in December last year. Nagatomi Pharmacy Corp., the Kyushu medical supplies shop bearing his family name, had grown to 23 dispensing pharmacies in Oita Prefecture .

Nagatomi had contemplated passing the company to his son, a licensed pharmacist in his 30s, but a sale seemed a better option, given the need to update the IT systems and attract talent. A Sapporo-based buyer, Medical System Network Co., paid about ¥3.2 billion ($30 million) in cash for it.

“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 percent of small-and midsize businesses in Japan lack successors, according to Jun Tsusaka, CEO of Nippon Sangyo Suishin Kiko Ltd., a private-equity firm in Tokyo. Yet, when it comes to selling, 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 the Japan head for TPG Capital LP.

Tsusaka formed NSSK in 2014 with other ex-TPG staffers after seeing the rise of succession-driven deals. He felt there’d be greater opportunities plumbing the middle market than chasing traditional large-cap stocks.

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

Almost all NSSK’s investments to date have involved family owners with succession woes. In 2017, it bought Bunkasha Publishing Co., a distributor of manga. 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 Bunkasha CEO Shintaro Omori, the owner chose NSSK mainly because of its understanding of the company’s needs and deep pockets. The amount wasn’t disclosed but most NSSK deals range from $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 in South Korea, where similar demographics exist.

A South Korean government report in March found that over 84 percent of mid-size firms don’t intend to pass the business to the next generation. Tax is a big reason. It’s not uncommon for owners in both countries to be subject to hefty charges. Korea’s 50 percent inheritance tax is the second-highest among OECD nations after Japan’s 55 percent.

Koo Kwang-mo, chairman of the giant LG Group made headlines last year after facing an inheritance tax bill of over $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 but doesn’t any more “because we earned money from selling the company.”

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 percent of new capital pools raised in 2018 versus 8 percent in 2012, according to research firm Preqin.

In January, Hong Sang-wuk, founder of Hong International Corp., sold his company to Orchestra Private Equity for 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 over a decade working at firms including Bain & Co., said he’s seen many firms grapple with succession issues. Orchestra scours the middle market for such companies, looking for those with untapped geographic-expansion potential. It now plans to increase Hong International’s presence in Europe and the U.S.

The surge in succession troubles has also proved a boon for 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. Over 80 percent 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.”

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