“Looking for funding?” asks the headline in the March 5 Wall Street Journal. “Better not say it’s all in the family.”
The article describes the plight of Ignite Sales Inc. of Addison, Texas, a software firm owned and run by three sisters. The sisters (plus their father, who is a founding board member, and one sister’s husband) love working together and attribute their company’s early success to their trust in each other. But Ignite Sales “has been warned by financing experts that venture-capital firms, newly tough in the wake of the dot-com fiasco, might balk at backing a family-run company.” The article even suggests that family companies like Ignite Sales may have to break up the family’s controlling ownership to gain access to capital markets.
I say: Balderdash! The Journal’s quoted experts overlooked other sources of equity capital that not only tolerate but, in some cases, target family businesses. Ignite Sales simply has to find investors who perceive family ownership as an asset, not a liability. There are plenty of these investors, and their numbers are growing. In the post-dot-com investing world, long-term values attributable to family businesses (which until two years ago were considered passé by many private investors) are coming up on the top of the list of investment criteria.
Family businesses typically have long operating histories, strong established brand names, high-quality assets and conservative financial structures. They provide strong growth opportunities if the owners can unlock “the business of the family” from the family business. The mere presence of the family as managers and owners provides a level of long-term commitment, heritage and dedication rarely seen in non-family companies.
In fact, the investment merits of family businesses have been well documented. Consider the success of Pitcairn Trust Company’s Family Heritage Fund, whose sole mission is to invest in successful family-owned companies—and whose return has outpaced any broad market index. (The Pitcairn Group LP is a strategic and financial partner to de Visscher & Co.) Over the last five years, the Family Heritage Fund’s total return has averaged 14.49% per year, as opposed to the Wilshire 500’s 9.7%. This 4.8% difference between the Heritage Fund and a broad market index market illustrates the “family effect” enjoyed by well-managed family businesses. If most venture capitalists hesitate to invest in family-owned businesses, that’s a reflection on the investors: They’re usually too impatient to wait for the “family effect” to kick in.
But venture capital isn’t the only equity capital source. What are your alternatives?
• Private equity funds demand significantly less control and lower returns than venture capitalists do. They tend to be more family-friendly because they’re not looking to make a quick killing: They’re happy to stick with an investment for three to five years, compared with venture capitalists’ one- to two-year horizons. Private equity funds’ biggest investors are insurance companies, pension funds and other large institutions that must maintain broad asset allocations (including family companies) in their portfolios. They don’t necessarily target family businesses, but they don’t rule them out or require family owners to step aside, as venture capital funds often do.
• Family business investors are a new and most interesting type of private equity fund. These “FBIs,” as they’re called, are mainly private individuals or family offices who’ve pooled their money to invest in family companies.
Because FBIs have a family business background, they perceive the “family effect” not just as neutral, but as a positive criterion they seek in all of their investments. FBIs are also more patient than venture capitalists or private equity funds; they sometimes invest for ten years or more. They search for a financial and strategic partnership with the family to create long-term value for them and for the business-owning family.
Obviously, at some point FBIs will want to exit their investment and return money to their own investors/families. Our experience tells us, however, that the form and nature of their exit are much more flexible than exits by venture capitalists or private funds. In one case I know of, the family agreed to pay all excess cash flow over a certain threshold to the FBI and provide the FBI with an exit over five years.
My own firm considers the family effect so significant a source of wealth that in January 2001 we established Family Capital Growth Partners, a private equity fund that specifically targets family businesses.
The chart below compares the investment criteria of these three equity investors.
| Three types of investors |
Venture capital |
Private equity |
Family business investor |
| Family friendliness |
Family = liability |
Neutral to lukewarm |
Family = asset |
| Control desired | >60% | > 50% | 30%-50% |
| Expected returns | 40% | 25%-40% | 17%-25% |
| Exit | 1-2 years | 3-5 years | 5-10 years |
When searching for an investment partner, you need to consider the partner’s parameters for exit, control, return and family-friendliness. In addition, you need to factor in the size of the investment fund, whether it be venture capital, private equity or FBI. The size of the fund determines the amount of capital the fund is looking to invest in individual companies to maintain a diversified portfolio. A $20 million PE fund might make five to seven investments of $3 million to $5 million. A $1 billion fund may make ten investments of $100 million or more.
The first step in your search is to clearly define why you need a financial partner. Is it to provide growth capital to the business or to allow some shareholders to exit the business, or both? Is it to provide long-term capital over the long haul or just for a one-time liquidity need?
The intended use of proceeds will often dictate the type of financial partner you need. Do you need a pure short-term financial partner, or one who can also give some strategic input? Do you need a partner with international experience and know-how?
Good financial partners can provide not only financial capital but also strategic advice, human capital and networking contacts. After all, they’re creating value for themselves when they create value for you.
What’s my advice to the three Texas sisters who run Ignite Sales? Since they need a $5 million equity infusion, they’d do well to target a $20 million private equity or FBI fund. They don’t have to let money come between them and their company. They just need to knock on the door of the right investors who will recognize the power of their family assets.
François de Visscher is founder and partner in de Visscher & Co., a Greenwich, Conn., financial consulting and investment banking firm for closely held and family companies (worldhq@devisscher.com).