Family businesses must look beyond traditional sources of capital

Just like any other business, a family business will need funding from time to time. Usually, this will be to fund growth, but it might also be necessary to manage liquidity for transitions. More than half of businesses that responded to a 2015 KPMG survey said that they were currently seeking external funding.

In most cases, raising capital comes down to selling equity. But selling equity often results in giving up control, and it’s no secret that family businesses are reluctant to do that. KPMG’s European Family Business Barometer, published in June 2014, found that 87% of businesses indicated that maintaining control was a key success factor.

Besides control, traditional equity investors, such as venture capital and private equity funds, tend to look for quick returns and a clearly articulated exit strategy. That means an IPO or a trade sale after three to seven years. Again, this isn’t something that fits into the culture of a family business. Families are patient, long-term investors.

An alternative route is debt. But, banks often don’t recognize the value of the intangible assets in a family business. The family bond that ties a business together and the sweat equity invested over multiple generations make family businesses what they are. However, when it comes to valuing those assets as collateral for a loan, banks are hesitant to recognize the true value. The result can be expensive debt, which is most certainly not patient in times of need.

Family businesses need to look beyond traditional sources of capital to fund their business in a way that aligns with their objectives and the underlying culture of ownership. It’s worth considering what a family business can offer investors that other businesses can’t.

So, what can family businesses offer that many other businesses can’t? Well, family businesses do have unique attributes which make for an attractive investment for the right investor:

A lower risk profile. When someone is managing a business with the intention of passing it onto their children, they are likely to act more responsibly than management who are chasing short term bonuses.

Sustainable growth. Family businesses pursue long terms goals and don’t chase short-term returns at the expense of long-term returns that underpin significant value.

A family bond can be far stronger than the traditional relationships that make up a business.

Higher returns on equity. The family business dynamic can create greater efficiency which results in a higher ROE.

The above attributes make for a safe and attractive return for patient investors.
The most appropriate investors often turn out to be other family businesses. This is commonly known as ‘patient capital’ because the investors understand family business.

Although patient capital may indeed be patient, it’s important for a business to provide a dividend policy that aligns the investor’s interests with those of the family. A popular mechanism to achieve an exit for a new investor is a guaranteed share buyback scheme. Such a scheme would result in the company buying back shares at predetermined prices, if and when profit targets are met. Alternatively, investors can be rewarded with growing dividends, based on a percentage of annual profits. That type of policy will give the investor unlimited upside, without creating a burden on the business.

Before seeking an investor, a family who is in business should ensure that they have considered the family’s investment policy and the needs of the current and future generations. The business strategy should be coherent in the context of its position in a competitive industry and that the business strategy must seriously consider the purpose of the family.

Allocation of capital should always be part of a longer-term strategy for the family and the business, rather than an afterthought that comes up only when capital is needed – either by the business or by the family.

The next step is to find an investor that buys into the family’s values and goals, and who’s interests are aligned with those of the family. Relationships with investors usually go awry when family and management want one thing, and the investor wants something else. The most important factor when taking on an investor is to make sure that the investor and the family have the same long-term goals.

There are investors out there who value the family business model. Finding them requires tapping into the right networks and making use of family business consultants with access to these networks. The search may also require patience. But, remember, making a rushed decision and choosing an investor whose objectives do not align with those of the family can have far-reaching consequences for the business. If a suitable investor cannot be found immediately, it is better to keep looking than to rush such an important decision.