Family businesses seek cash

In the future, how will families finance their businesses? And how might new sources of finance affect the structure of family businesses?

I ask these questions because I know of many businesses that are looking to expand outside of their home markets but lack the resources to do so.

Where can they find the money they need in order to expand?

Family businesses are famous for their conservative financial priorities. They prefer to finance growth through retained earnings. And when they can’t, they borrow money from a bank with whom they have built a long relationship.

Typically, family businesses don’t want to give up equity. But in the future, they may have to do so in order to stay competitive. This trend isn’t such a bad thing. Indeed, the need to gain capital from other sources for growth might help to professionalize family business management.

Before they commit resources, investors — whether they are other family businesses or private equity firms — will want assurances that the family business’s management is professionally structured. They will want to see the family making efforts in the following areas:

  • Meritocracy. Family businesses need to show external investors that they are meritocratic at all levels, particularly when family members are appointed. They have to counter external concerns about nepotism.
  • Outside management. Family businesses need to hire board members from outside the family. And they need to recruit highly trained outsiders for senior management positions.

While family businesses must professionalize their management to gain the attention of investors, investors also need to make themselves more attractive to family businesses.

They need to show that they understand the concept of “patient capital” and that they will not sell their stake too readily. Patient capital is about committing to long-term objectives rather than short-term gains – something central to most family businesses.

Private equity groups have traditionally planned for an exit three to five years after their initial investment. That doesn’t go down well with family businesses – hence the antipathy between the two groups.

To convince family businesses to part with equity, investors will need to think about at least doubling their normal investment periods.

The good news is that I see many family businesses professionalizing their management in order to attract outside investors, and many investors buying into the patient capital concept. These are trends that, in the future, can only benefit all parties.

Guido Corbetta, Professor of Strategic Management and Family Business, Bocconi University

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