When to consider external sources of funding

By Rustom J. Desai

The value proposition of your company must be well documented, rehearsed and agreed to by all stakeholders.

Owners of small and medium-sized family businesses are often faced with a conundrum: They know they have something special that they have built with their blood, sweat, tears and money. But they also know that for the business to reach its true potential, family money is either not going to be sufficient or is going to expose the family to an unacceptable level of risk. In other words, they need external sources of funding in order to take the business to the next level.

The business owners might first turn to friends and extended family and then,  if the company continues to show promise, to venture capitalists, private equity investors, other family offices, large companies that have a strategic interest in the business (strategic funders) and so on. In the United States, there is a reasonably well-developed ecosystem that provides funding to small businesses looking to grow.

How should your family business get ready to take the show on the road? What aspects of your story are going to resonate with potential investors? What are the pitfalls that you should avoid?

Clear value proposition

Investors who may not be experts in your field should be able to understand very clearly what problem your product or service will solve and the financial impact it will have on its users. Yes, some will want to understand technical details,-but for the most part, investor time and attention span is limited. The value proposition of your company must be well documented, rehearsed and agreed to by all stakeholders.

Why your family enterprise?

It’s important for investors to hear how your family has worked to make this entity highly attractive and separate from the pack. Most family enterprises have a unique and powerful story to tell here. Do you focus on developing future leaders? Do you have strong values that guide all important decisions? Is there a story to be told about the high level of commitment (both personal and financial) you have made to the growth of the company? Find that nugget that puts your family enterprise on a growth trajectory that sets it apart.

Ownership, governance and management

Prior to letting external investors in, the family must gain full alignment on these three topics. Having ownership, governance and management issues in order will provide clarity to investors and will demonstrate that they would be investing in a company where the role of the family is clearly defined.

Ownership: How much of your company’s ownership are you are willing to give up? Answering to this question will aid in determining not only valuation, but also what kind of investor group you might get interest from. Friends and family are usually not concerned with this topic, but VCs want to know that they can acquire enough ownership to drive influence on key strategic decisions.

Governance: While governance rights generally scale with ownership, this does not have to be the case. Different classes of stock can be offered to different owner groups. It is possible, for example, for certain family members to retain more voting rights than their ownership percentage might indicate. At Facebook, for example, Mark Zuckerberg and his allies own only 18% of the stock, but they have majority voting rights.

Management: Do you see yourself and future generations retaining key roles in the company’s future? Or is the family looking for an opportunity to scale back from involvement in the day to day and transition management to professionals? Once again, the answer to this question will guide the kind of investor your company will attract. Some want more control of management, others less.

Whether your family wants to continue to run the enterprise for generations with maximum control of the board or to use a funding event as the beginning of an exit plan, it is your company. But one thing is for sure: Defining and communicating your position will significantly increase the probability that you will find the right investor for the long-term success of the enterprise.

Family vs. enterprise

As with any business, stereotypes exist about what an investor should expect when dealing with a family enterprise. One I have heard often is the sense that family enterprises struggle to separate the family from the business. Right or wrong, because of this stereotype investors will want to know that the family has clearly defined how they and enterprise operate — together and separately.

Sitting key family stakeholders down and documenting what I call a “family business governance framework” can be incredibly valuable. This document addresses some very key topics:

1)    Roles and responsibilities: Which family member plays what part in the running of the business.

2)    Succession planning: What happens if/when a family member is no longer able to perform their role in the company.

3)    Decision-making matrix: What key decisions require unanimous consent or majority consent of the shareholders and/or board.


Once your family has had a chance to work through these topics, it will be well on its way to attract the right kind of external funding. Along with this funding will come other benefits, such as access to talent, availability of an external viewpoint and potential entry into new markets. Bon voyage!


Rustom J. Desai is a seasoned board director who has dealt firsthand with many issues related to tech and family businesses. He is also a visiting faculty member at Cornell University’s SC Johnson Graduate School of Management.

May/June 2021

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