As pointed out by Christophe Bernard in his column on 18 October 2014, some 42% of the respondents to the Family Business Global Survey have, at some point in their business, received direct investment from high net worth individuals (HNWI) and other family business investment pools. The experience was commended by an overwhelming majority (92%) who saw it as positive, in particular when comparing that source of financing to others available to them. While the news is overall positive, it is also useful to take off the pink glasses and investigate the darker sides of the relationship in the spirit that “good can always be done better”. In the next section, we review some of the perceived impediments to these otherwise fruitful relationships.
A vast majority of responding family businesses, while viewing very positively HNWIs expertise, willingness to get personally involved and long-term investment expectations, also feared their possible interference with management. In other words, while the tender embrace was welcome, it was feared the courtship could easily deteriorate into harassment and a bear hug! Some 69% of the respondents saw interference as a very real threat to the blissful consummation of the relationship.
It is easy to see why this would come to be rated so high in the fear list. As highlighted in the survey, HNWI are valued not only for their cash but also for their intimate knowledge of the industry, the professional networks they have established, their reasonable return expectations and investment horizons and their familiarity of the family business cultures. This combination of desired attributes often implies that the preferred HNWI investors are intimately close to the investee’s businesses. This proximity, which in a way is the key source of value added, is also potentially the premise for interference. With familiarity often comes the belief that “one knows better” and hence the desire to “share the wisdom”, when such sharing is not necessarily welcome. Finding the right balance between valued contributions and undue interference seems to be the key to a satisfying and sustainable investment relationship. It often seems to hedge on whether the contributions are asked for or imposed on an unwilling partner. It would seem to make sense to delicately balance what would be referred to as strategic advice from the more delicate decision making.
An interesting issue raised by the survey respondents is the fear that HNWI investors, while relatively well aligned in terms of investment horizons, would actually be rather demanding in terms of required returns. Interestingly enough, these perceptions are very much in line with their own expectations as investors, so clearly the fears are warranted! But these numbers may be somewhat misleading, in particular with the rather loose definition used of what constitutes “demanding” in terms of returns. Clearly, equity investors would expect returns in line with equity levels of risk, and those cannot be compared to, for example, bank lenders. Also, it should be noted that these returns have to be put side to side with the expected value contributions from these HNWIs. In a sense, the situation is very similar to the one faced by technology entrepreneurs talking to venture capitalists: clearly, the VCs expected rates of return can only be justified by their provision of a lot more than just money! Put differently, if it was just about the money, it would be impossible to justify their required rates of returns.
The prime governance factors for HNWI to invest in FBs are the potential to acquire a board seat and the potential to acquire a majority stake. Both these factors underline the fear outlined above that the investment has a control hidden agenda, i.e. that while the objectives may be aligned now they will soon turn into conflicts of interests. Again, it is interesting to note the quasi-schizophrenic nature of this attribute: while most HNWI (amongst which a majority of FB types) would seek control rights (through a board seat or outright majority ownership) in their investments, they would similarly resent such level of interference if required by investors in their own companies! It is easy to see that the two antagonistic points of view simply match the different perspectives: control matters in family businesses, and both sides have clearly had to deal with control issues in their pasts. Board seats are clearly not a big issue as long as they don’t meaningfully change the balance of power and control at the helm of the company. But the perspective of a change of majority ownership may require some form of standstill agreement to alleviate the fears of some recipients.
We already alluded above to some potential measures to reduce the potential antagonisms between HNWI investors and family business recipients. A couple of extra measures could be envisioned.
To summarize, the hurdles to bringing in HNWIs and other family businesses as equity investors are not insignificant but the potential for such interactions is huge. What needs to be created is a deal environment that eliminates the key ambiguities of such transactions, most notably those surrounding control and management interference.