If your family firm is considering working with outside investors, remember that the old axiom “knowledge is power” still holds true. For example, bringing in an outside investor does not have to take the “family” out of family firm. Yet, as with any change in ownership structure, you need to consider the types of investors who are going to provide a good fit for your business.
Based on research conducted with my co-authors Miguel Meuleman and Sophie Manigart on the different governance scenarios that may arise when family owners attract outside capital, below we examine the common ways family firms can work with outside investors, and the governance implications to consider for each one. For family firms, forewarned means forearmed.
The four scenarios for working with outside investors
This starts with thinking about two key questions:
• Do you want external investors to provide liquidity to the family, or to the firm?
• And do you want family control to be ceded or retained over the long term?
Based on the differing responses to these two question, below I've detailed the four basic ways that family businesses can work with outside investors—and the governance implications to consider for each. By first clarifying your overall aims for working with outside investors, you can then select which of these ways to work with outside investors would be most beneficial to your goals.
1. Gradual exit (liquidity for the family, ceding control)
Families in this scenario are looking to eventually bow out of their family business, but not too abruptly, in order to maximise value. In this position, owners often choose to diversify some of their wealth in the short term, before their final exit. To this end, they seek equity investments that only involve a partial change in ownership and don’t provide extra capital to the firm.
A good example of this is the 2003 buyout of the fifth generation-owned agricultural equipment manufacturer La Buvette of France. The family still felt their firm had potential, but they lacked successors and intended to withdraw. They joined forces with Alliance Entreprendre, a finance firm which helped streamline management processes right away. The family relinquished the chief executive position and took a minority stake while they prepared for a joint exit.
2. Extend the firm (liquidity for the firm, ceding control)
In this scenario, family members are planning for a medium-term exit. They want to sell, but wish to further develop the business to its full potential before doing so. To do this, family members retain their shares and seek outside investors to provide an injection of capital to the firm.
In 2014, Molecular Products Group, a UK-based manufacturer of chemistry-based products, were in just this position. They wanted a medium-term exit, but had just started to internationalise. Business Growth Fund (BGF) stepped in, providing capital and strengthening key roles. Three years later, when profits had doubled, both family and investor sold the firm on and exited successfully.
3. Replacement capital (liquidity for the family, enduring control)
Families in this scenario want to cash out some of their shareholdings but also want to pass the business on to the next generation, who may or may not be interested. These long-term aims probably stretch beyond the outside investor’s time horizon.
For example, Market Basket, a New England supermarket chain, was almost brought to its knees by a conflict between two cousins. This was resolved when one branch of the family purchased the 50.5% stake they did not already own from the other branch, with funding from the Blackstone Group and a significant amount of debt. In deals such as this, where the firm’s capital generally is not increased, management focus is likely to be more trained on efficiency gains than growth.
4. Strategic investments and turn-around (liquidity for the firm, enduring control)
In the fourth scenario, the family are looking to hold on for the long term. Here, it is important to distinguish between two possibilities: “strategic investment”, where family firms are looking to grow, and “turn-around”, where the firm aims to strengthen their financial structure. In both cases, outside investors bring in extra capital to the firm, not the family.
In 2015, craft brewery Dogfish Head needed money to continue growing. A deal-breaker, however, was that any new investor would need to safeguard the company's culture of smart over fast growth. They also didn’t want the company to go public. LNK Partners eventually entered with a 15% stake and one seat on the brewery's four-member board.
Meanwhile, Gimv's 2009 investment in Belgian baked-goods company Vandemoortele was a clear case of strengthening the balance sheet. The investment allowed the fourth-generation family firm to turn a corner. After several successful years, Gimv's share was sold back to the family.
As you can see, there is more than one governance model for how a family business can successfully work with outsider investors. Being armed with that knowledge can help you determine the right type of investor relationship for your circumstances.
For more information, read Governance Implications of Attracting External Equity Investors In Private Family Firms by Jeroen Neckebrouck, Miguel Meuleman and Sophie Manigart, published by Academy of Management Perspectives.