When a business has been painstakingly built by successive generations, it makes sense that the family would want to maintain a firm hold on the business through majority ownership as well as keeping the daily management within the company.
On the other hand, most family businesses also acknowledge that they have need for skills and expertise that only the outside world can provide, as well as a need for financing to grow the business further.
Where do family businesses turn to for outside assistance? To keep the company growing toward success, a family business must come to grips with two interconnected challenges: that of achieving strong business performance with an ownership structure that is capable of providing sufficient capital for growth while allowing the family to control key parts of the business.
While a family business can balance heavy family involvement with the need for outside skills and expertise by establishing boards that are comprised, at least in part by non-family members, how do they balance the need for growth capital into the equation as well?
While bank debt is the most prevalent method for sourcing finance for the family business, the reality is that the current economic climate has had a negative impact on the likelihood of financing projects through bank loans.
Not only have banks tightened their lending, they’ve also increased the level of information required from family businesses when submitting a loan application. This is problematic for family businesses who value their privacy. Even though the business strategies are well documented and plans for success are listed step by step in the application, banks expect disclosure of details like turnover, which family businesses are reluctant to share.
Family businesses also feel that banks do not understand the unique characteristics of their business, and that this prevents them from appreciating the some of the sensitivities inherent in running a family-owned company. This shows that family businesses see themselves as private entities, which logically rules out public sources of financing. Furthermore, the fact that bank loans are the most prevalent forms of raising capital reflects the importance that most family businesses place on retaining equity.
Preserving family control and independence are consequently important goals, as a result of the fact that the family business is seen as a legacy that must be protected for future generations. This strong desire of family businesses to retain majority ownership creates the opportunity for high net worth individuals (HNWIs) to play a role in providing alternative funding.
The possibility of family conflict is the biggest deterrent for potential HNWIs. For the most part, HNWIs are happy to get involved and offer their advice as well as their capital, but they’d like to have an equity stake in return and they like the idea of having board-level involvement in family businesses in order to exercise a degree of influence on company management.
Family businesses can remove the looming possibility of family conflict by putting the right formalized corporate governance structures in place. This envisages the establishment of an independent board of directors, which requires issuing clear lines of control to alleviate these concerns the HNWI might have. On the other hand, while the family business might consider offering equity in return for HNWI investment, there’s the fear that the HNWI might seek to gain a controlling interest. By formalizing and defining the scope of the HNWI’s involvement, it’s possible to manage concerns around family control interference.
Ultimately, for the family business, it all boils down to balancing the need for control with acceptance that growth always comes at a cost, and using this as the foundation to put measures in place to allow the board (and the HNWI) the ability to intervene and contribute without upsetting the family business’s cherished strategic independence. Fortunately, because of the very nature of the business, balance is something that seems to come more naturally to family.
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