Melanie Stern is Section Editor of Families in Business magazine.
While global IPO and share market returns languish at historical lows, venture capitalists could step in as family business capital providers – but both sides need to work on their perceptions of one another to build a successful marriage, says Melanie Stern
A curious contradiction within the family business sector is that, despite being inherently long-term, most incumbents have a shockingly short-term approach to financial planning. Statistics support this – last Autumn's survey of finance sourcing from Manchester Business School revealed that over 72% of the UK's family businesses stick to bank overdrafts and loans as their main primary source of development finance, with over 22% choosing to turn to their own equity. Startingly, just 0.9% of the UK's family businesses utilise venture capital, with observers putting this down to the perceived loss of control venture capital injections bring.
A second curious contradiction is the willingness of family businesses to turn to the IPO markets instead of the venture capital sector for cash after they have exhausted these possibilities. Is selling the majority of stock in one's firm to the global public not loss of control – the very reason families avoid venture capitalists? If yes, then why go there? Tony Dunn, corporate finance partner with family business advisors Grant Thornton, believes this is down to simple PR issues. "The stock markets are very well publicised – watch the news at the end of the day, and they talk about the FTSE 100 and how it's moved that day," Dunn explains. "Venture capital is a relatively new idea compared to the stock markets."
The result of a convergence between a historically short-term financial outlook, fear of loss of control and outdated financial knowledge limited to the most risk-free 'high-street' banking offerings, one cannot help wondering how family companies survive in ever competitive and uncertain global markets with such a curtailed approach to their future – much less do any succession or expansion planning. At family owned and family business-centric UK venture capitalist SandAire Private Equity, MD David Williams warns that this parochial approach cannot stand up in today's competitive and testing business environment. "Traditionally, family companies funded themselves by their bootstraps, reinvesting family money and profits, or bank money," Williams reveals. "While it is entirely understandable that not all family businesses want to grow and want to stay the same size, I would warn against making a conscious decision to stand still because you will soon start moving backwards." Dunn agrees; "Most family businesses seem to run themselves on cash. It isn't as strategic as it might be at a larger corporate. As long as the cash is rolling in and the bank manager is happy, most family companies wouldn't be worried."
So, why would a family business be interested in venture capital? There are a number of perennial and current market-specific reasons to at least investigate it. Succession transition – pertinent to every business owner who hopes to pass their company to their children – can be made much smoother with the injection of capital; competition is a tough challenge for every business in every market and should a family business owner decide to expand their product pallet or simply make themselves bigger accordingly, venture capital will be able to provide the often substantial sums necessary. Or, families may simply want to realise some of the cash tied up in their business to start other ventures, pay off the mortgage or simply put the kids through school. Either way, venture capital is a way to finance a family business and realise some of its value without the pain of having to take it public. It is also a useful option while global IPO markets are so depressed. What's stopping the propagation of a fruitful relationship? Some very unfortunate misconceptions on both sides of one another's motives and inner workings.
For a start, many families see venture capitalists as vultures looking to steal their business away from under their noses, and fear that they will have board members or non-executive directors thrust upon them that will see them lose control of their business. In fact, while it is true that each venture capitalist has a different policy on what level of involvement it has in its investments, most understand that their role is just to realise the expected wealth through ensuring that pre-agreed plans are seen through effectively, rather than to take on company and market-specific operations. "Certain venture capitalists are known to be very active – but someone like 3i, for instance, is known to be very hands off; it is there to be contacted if need be, other than that, the firm may receive management accounts and meet with the company occasionally, but would not attend board meetings," Dunn explains. "Other venture capitalists could be more active in their involvement – I have seen some that send two people along to every board meeting every month. They might turn up to board meetings to monitor progress, and hopefully add some value in financial questioning, but definitely not to run the business – they don't have the capability to do that."
Meanwhile, venture capitalists are eager to change things and capitalise on a potentially big profit line, but they must first banish some of their own gremlins. "From our side of the fence, I think some of my venture capitalist colleagues view family businesses as lifestyle companies that are sub-optimal in profit realisation and shareholder value maximisation, and see them as being more interested in an easy life," SandAire's Williams reveals.
As well as having a less than perfect reputation to rectify, venture capitalists also have to grapple with inherited financial styles within family businesses, that do not look favourably upon vehicles like venture capital. "Some family business leaders have this message about not losing the business by allowing other people into it drummed into them from an early age, but this sometimes leads to a 'siege' mentality when it comes to taking on external investors, so they just never do," says SandAire's Williams. "Their prejudice is that we are looking to rip them off in some way or impose draconian terms – it's a free market and market dynamics just don't permit us to do that. Once they've sat down and talked with us we hope that this mistrust turns out to be just an issue of understanding and was perhaps misplaced." Dunn adds: "People view venture capitalists as asset strippers. Asset stripping is the wrong term to use. At the end of the day, the goal should be common – the creation of shareholder wealth/value and this should benefit all shareholders. Ownership issues are at the heart of these fears. People are fixed in their minds that they must have 50% (ownership) and if they haven't, they feel they've lost control. In reality, because of the way in which lawyers draft the documentation, shareholding is almost irrelevant."
Both Williams and Dunn acknowledge that for this stymied relationship to start growing, their sector will need to step up its educational efforts and assuage fears with facts, and there has already been a small shift in sentiment from the incoming generation of family business leaders. "There is increasing acceptance from the 'MBA generation' – those who have an MBA and outside experience then come back to the family business – of using other people's money to turn a UK£10 million business with a family stake of 100% into a £100 million business which the family holds perhaps 60 or 70% in. This is far more valuable as an entity than just staying small and in control, not exploiting all the opportunities available to them," Williams believes.
The global downturn and current lows in the share and IPO markets have had an effect on almost every business sphere; venture capitalists too, traditionally champions of tech ventures, dot-coms and risky startups, have found that their usual pickings are scarce. Not only this – they have become more risk averse than ever, and though some of them find it hard to admit, many have been 'rightsizing' their portfolios and reviewing their investment models to include less riskier companies. Grant Thornton's Dunn says that this could create a window of opportunity for family businesses to gain ground in the sector. "The venture capitalist market is moving towards a model whereby they are not looking for huge growth opportunities," Dunn concedes. "They are looking for steady investments that may not see them double their money in a year but on longer-term basis will deliver steady growth. If you have a family business with a good track record of decent performance and good but not outstanding growth, then the current market makes you a very attractive proposition."
"Family business is an area we think has been neglected by the venture capital industry", concludes Williams. "A considerable amount has gone into technology and dot-com's over the last five years, and a considerable amount into the huge management buyouts you read about in the Financial Times, but that's left an important field uncatered for."