Analyzing the results of the KPMG Family Business Global Survey, one cannot escape being surprised by the natural affinities between HNWIs and family businesses. As outlined in the global report, most of the HNWIs interviewed were rooted in family businesses to start with, having inherited money from a family business or still being connected to one. Those without the legacy connection to family businesses, often first generation entrepreneurs, were probably just family business problems waiting to happen…
While this was mentioned tongue in cheek, these potential affinities are real and strong. So what would it take to convert them into hard investments for the benefit of both parties? What would it take to make the family business even more enticing and attractive for HNWI investors? What does it take to move beyond the casual courtship into a real long-term commitment? And what is required to keep the flame alive and well between those two emotionally-challenging parties? Affinity financing, a rather ancient concept, is based on capitalizing not only on financial benefits but also emotional ones. To paraphrase the title of Frédéric Beigbeder novel published in 1997, “can love actually last more than 3 years”?
Some 20% of the HNWI respondents to the survey showed a great interest in investing in family businesses, with another 42% showing some interest. That could be read as a 62% vote of attraction but at the same time, where asked if they had a preference for investing in family businesses, respondents were more ambiguous. 39% expressed a clear preference for investing in family firms but some 36% did not really care, not to mention the 25% who definitely preferred non-family entities. In other words, the beauty pageant vote does not necessarily seem to translate into wedding proposals… The bride is attractive, the groom may be interested but is definitely not blind nor totally love struck!
The factors most admired in the target investee firm, as anticipated, were the long-term view, a similar understanding of risk, mutual understanding that is anticipated to render negotiations easier, a clear focus on capital preservation, a more personal relationship, and similar values. To take the bride’s analogy one step further, she seems to carry the right values and heritage. But as one would anticipate, that may not be sufficient to carry the day. Respondents also point out the possibility of conflict/drama among family members, the difficulty in obtaining equity positions, the lower financial reporting standards and off-the-book issues, unclear strategies often subservient to the ‘long-term good of the family’, etc.
The image that emerges is one of a complex relationship built upon a strong attraction but also facing major structural hurdles. These challenges are very similar to the ones faced by crowdfunding platforms, the latest iteration on the affinity financing concept. What investors look for is not only a form of financial return (in the form of a product for Kickstarter or IndieGoGo) but an affiliation with the designer and entrepreneurs, i.e. to “belong” to a special club, those who enabled the creation of a new venture. An even more venturesome analogy would be to the outsider marrying into a large family business. The experience of in-laws is often complicated, to put it mildly. The family’s immune system often reacts vigorously against what is perceived as a potential threat. But families that have adopted wide-ranging inclusiveness policies, such as J.M. Huber in the US, facilitating the access of these outside parties into the family, can attest to the fact that these in-laws can bring invaluable outside perspectives and new skills. As such they can become major contributors to the family business that adopted them. In the longer term, they often turn into the biggest supporters of the family values, bringing in the extra zeal of the newly converted and defending aggressively the very values that caused them headaches at the beginning of the relationship.
The analogies drawn were not just for intellectual purposes. They may provide some interesting directions for improving the likelihood of deals between HNWI investors and family firms, for the benefit of both. As the new outside force into the family business, the HNWI investors would normally expect professional management elements to be put in place. They would expect to be included in the decision-making mechanisms, either through a board seat or a significant stake in the company. Similarly, they would like to get a clear view on the future of governance, i.e. succession planning for management and ownership. Summarized, they expect to be treated like a “member of the club”, no more but definitely no less.
So, how do you facilitate the incorporation of these external investors into your family firm? First, recognize that this is indeed a form of affinity financing. These HNWI investors appreciate the family values and what they convey at the business level. This is precisely what they want to invest in. So they expect to feel welcome and adopted. And yes, that could very much mean an invitation to the annual family get-together. HNWI investors are more likely to commit resources if there is a clear indication that the intent is to treat them as family owners, i.e. let them contribute to and share the major strategic decisions.
What the survey highlighted, interestingly, was the schizophrenic nature that relationship between HNWIs and family businesses can sometimes take, one of strong attraction and equally violent rejection. On the one hand, from the HNWI investor, the shared values are the drivers of the desire to build something long-term together. But on the other hand, from the family business point of view, these values are so strongly imbedded and personal that the outsider still needs to be treated as a foreign agent not worthy of full adoption. It cannot be affinity financing… without the emotional benefits!
And this is where a cultural revolution needs to happen on the family business front.. If an outside investment is going to be accepted based on affinity and emotions, then these factors better be grounded in the value proposition. A long-term investment horizon, flexibility and ability to act quickly are the result of a trusting culture developed over generations; any newcomer would have to be integrated into those mechanisms. Expecting a HNWI to commit to your family business firm but not expecting the family treatment is not realistic. In other words, when the family business is building its value proposition on a strong alignment to its family values, it must also make sure that the investor will be fully exposed to those values, not just cosmetically. You cannot trade emotional returns for real ones without actually delivering them.
Yes, there is a natural interest by HNWIs to invest in family businesses. Their long-term investment horizon, their commitment to strong values and legacy, their deeply personal relationships, etc. are all attractive to outside parties. But those are just premises for a possible business relationship. To make it happen, you will either have to open the door fully to those emotional benefits or adopt governance principles in line with the best non-family firms. Too often, family firms err on the side of over-playing the alignment of values and under-delivering on the governance side. It can be an either/or decision but better still, to improve the odds of great long-term relationships, it should be both. Combining solid emotional benefits and best practice governance is still the most predictable route to investment nirvana.