On the face of it, private equity and family businesses should be allergic to each other. Family businesses are long-term affairs, while private equity houses are often characterised as wham-bam-thank-you-mam-merchants who just want to maximise profit and get out after five years. Some family business owners look with suspicion at private equity. But the truth about their interaction is a little more complex.
Brian Livingston, head of private equity at investment management firm Smith & Williamson, says there are two reasons a family business might call on private equity. Firstly, it may want to develop the business, perhaps moving into a new geography, making capital investments, acquiring competitors or maybe building a new factory. Secondly, some or all of the family wants to liquidise assets, maybe through an initial public offering, maybe one family member wants to buy another’s stake, or maybe the founder wants to de-risk their assets by liquidising and reinvesting.
So why turn to private equity? Gordon Hague, director at private equity firm 3i, which has been investing in family businesses since 1945, says: “The first question is, can I grow my business faster by working with these people than on my own? And then it’s about alignment in terms of what we are trying to create.” The value of a private equity house’s expertise is obvious. Family business owners who have never expanded overseas, for example, need help to do so. In terms of “alignment” the benefit of private equity is that unlike an adviser reliant on fees, it is an equity partner in the business and it is in the firm’s interests to maximise the value of the business.
There will of course be another liquidity moment later on when the private equity firm wants to realise its investment. And here’s the rub. Livingston says that this is normally a question of 100% of the business being sold. A family buy-back is tricky because it might be in the interest of the family members not to maximise the business’s value during the private equity period. Also, there is no competition for the stake, so the price may not be as high as it would be in the open market. “The family business is ended the day the private equity is invested. But you have a short interregnum before the ultimate exit,” Livingston says.
Hague, however, says that more complex arrangements are possible. He cites the case of Senoble, a fourth-generation French dairy products business, which wanted help with funding acquisitions and restructuring the shareholder base to ease succession. In that case 3i became a partner for four years, helped double overseas sales, and then sold back their share of the business to the family.
He also gives the example of Williams Lea, a family-owned outsourcing company. The private equity house took 38% of the business and funded the acquisition of three US competitors, before selling their stake. They helped some family members to cash out, but also ring-fenced the holdings of others who wanted to keep their share of the business. “When we sold we would only sell to someone who respected the family requirements,” says Hague.
In many cases, though, private equity is involved with the family when the family wants to cash out. The private equity involvement is designed to get as much money as possible from that liquidity event.
There is another way that family businesses can be involved with private equity, and that is when the family office acts as a limited partner or investor rather than being the general partner or the company invested in. Jonathan Berman, corporate partner at law firm Mishcon de Reya, says family businesses and family offices often want “long-term, stable assets that provide a positive cash flow and income”.
Those who want to invest big sums have limited opportunities and so “are inclined to partner with investment banks and private equity houses who have greater access to the opportunities, rather than relying on direct investment and co-investment”, Berman says.
So private equity brings in opportunities that family offices would not otherwise have. Many family offices fund private equity deals. For example, a private equity house might come to them and tell them there is an opportunity in, say, oil and gas. The family offices wouldn’t get into that field themselves but with the track record and the support of the private equity firm they can. Family businesses are often more comfortable with the reliable, stable corporate environment rather than investing with entrepreneurs. At the moment, with banks unwilling to lend, family offices are increasingly being seen as a potential source of funding.
This article first appeared in CampdenFB, issue 53