Show Me More Than The Money

Show Me More Than The Money

Family Business Leaders Who View Private Equity Firms Only As Funding Sources
May Miss Several Opportunities To Realize Their Firms’ Potential

by Joseph F. Trustey

Family businesses are faring better than many other sectors of the economy. But new data reveal that many companies are not quite as robust as their owners might think.

In raw financial terms, family-run enterprises are remarkably secure right now. At a time when corporate debt levels remain high, many family businesses carry almost no debt.According to the latest American Family Business Survey, average revenues have climbed 50% in the last five years, and almost two-thirds of business owners are very optimistic about their prospects. Many can and will self-fund some growth, and their owners therefore see little reason to bring in outside equity investors.

That’s where their perceptions may work against them.

When they look at private equity firms purely as sources of capital, for example, family business owners overlook golden opportunities to address limitations they may not fully recognize. They may also forfeit favorable ways of pushing their businesses to their full potential. Later in this article, we will look at five ways in which the right relationship with a private equity partner can make a lasting difference to a family firm’s vitality.

Most owners of family-run companies have good reason to think the way they do. After all, they have achieved striking levels of success with very little outside intervention. In the U.S., “friends and family” capital for start-ups and growing firms outweighs venture money by 1.27:1, according to the Global Entrepreneurship Monitor study. Many can tell first-hand war stories of entrepreneurs they’ve known who have had control wrested away by outside investors. Little wonder that a 2002 survey by Manchester Business School in the U.K. showed most family-run firms avoid pursuing venture capital when they plot their growth or plan succession from one generation to the next.

Now there is evidence that family-run firms have become more cautious about non-family involvement. According to the 2002 American Family Business Survey, even accountants and lawyers – the outsiders family firms have always trusted most – are viewed less warmly. Perhaps because of the fall-out from the recent corporate scandals, only 35% of poll respondents rank their accountant as their “most trusted business advisor” compared to 44% five years ago.

“Family first” may have been a fine philosophy for the start-up years, but it is a limiting approach when a business has matured. The hallmarks show up in poll results. More than 60% of family businesses lack written strategic plans; almost half have boards that meet only once or twice a year, with those boards consisting primarily of family members. And 45% list “attracting non-family managers” as their most pressing challenge, according to the American Family Business poll.

The right kind of private equity firm can do much to allay the risks implicit in those results.

Private equity partners often buy a minority interest in the firms in which they invest, and they are more interested in assisting businesses that have attained solid levels of revenue and profitability.

There are five distinct areas where private equity partners offer significant value:

Sharper strategic direction.Outside perspectives can introduce fresh thinking that catapults company growth. A good case in point: industrial signage manufacturer EMED Co. After 20 years of 4% to 5% annual growth and profitability, EMED was viewed as an excellent manufacturing company that was not maximizing its marketing efforts. With a veteran private equity firm as its partner, EMED was able to identify and build a complementary competency in marketing. The sign maker expanded relationships with its best customers, developed relationships with new customers, and established an outbound telemarketing operation. Upshot: EMED is now set to achieve double-digit growth over the next several years, significantly increasing its value to strategic buyers or in the public market. 

Stronger management talent. Skilled executives quite often turn down promising opportunities in family-run firms because they fear that family members will micromanage. Another concern is that they will be caught up in a family feud. The backing of an independent private equity partner can provide the necessary assurance, balance, and the far-reaching contacts to identify and evaluate top talent.

At AlphaSmart, a maker of portable “computer companion” products that help students improve basic skills such as writing and keyboarding while making schoolteachers more productive, its private equity partner helped attract very accomplished Board members, hire a seasoned chief financial officer, and a director of operations.The new management team positioned the firm for its move from a single-product hardware company to a broad-based education technology provider serving school districts across the United States and around the world.

More effective boards of directors. Private equity partners will usually take a seat on the firm’s board and often bring in other experienced independent board members as well as their own broad business backgrounds. Family-business boards are underutilized, according to the American Family Business Survey. Fully 13% of family firms have boards that never meet. And only 30% of those with board subcommittees have an audit subcommittee. Family firms that lack audit oversight run greater risks, especially now that external scrutiny is ratcheting up.

Expanded sales opportunities. The right private equity firm can quickly broaden the sales horizons of a growing company. For FleetCor Technologies, a provider of fleet-management products to small businesses, the equity partner’s array of portfolio companies added substantially to its list of prospects. Others have found that equity partners can help them break their reliance on very limited offerings, such as a single product.

More robust business network.Seasoned private equity firms have gold-plated connections worldwide, and they make them available to family business clients. Typically, the firm will have offices in several cities around the world. It will have handled scores of strategic acquisitions and mergers, and invested in hundreds of small businesses. If the family business has outgrown its bank or legal counsel, a good equity partner can quickly draw up a shortlist of key candidates.

Although owners of family-run businesses may welcome the varied funding options that private equity firms can offer, they may not readily recognize the need for outside advice or stronger networks. There has never been a better time to address those needs. In the next five years, nearly 40% of family firms are due for a leadership change as their founders approach retirement; historically, less than 30% of family companies survive to the second generation.Owners who look to equity partners for more than just money will be adding significant strength to their businesses for the long haul.

Joseph F. Trustey is a managing partner of Summit Partners, a global private equity firm that invests in growing, profitable, privately held companies with proven business models, records of revenue and earnings growth, and the leadership capable of sustaining that growth. He can be contacted at: 617.824-1040, or jtrustey@summitpartners.com .