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All in the Family: The Upside of Investing in Family-Owned Companies

By Bassem A. Mansour
Co-Chief Executive Officer, Resilience Capital Partners

Family-owned companies, especially those that have been in existence for decades and have engaged multiple generations of the family, often find that their growth has plateaued. This recognition can create opportunities – for them, and for prospective investors in the company, especially private equity firms and other institutions with resources, expertise and experience. New investors can help generate genuinely new value, and spark substantial growth.

There is tremendous potential in this distinctive sector of closely held companies, since many longtime family-owned companies are highly appealing. They frequently are well entrenched in their markets, have decades of success even during difficult times and have cycled through markets, always – by definition – surviving.

However, many of them have not really tried to address the kinds of opportunities new investment can bring to the table, such as operational excellence, meaningful acquisitions, new market entry or other ways to drive the business forward.

In some cases, the family does not have, or is not willing to invest, the capital required to take advantage of these opportunities. Sometimes, the owners simply are unwilling to re-risk the capital originally used to build the business in the first place.

New investors, such as private equity firms, have a different mentality of ownership and different perspectives on value creation than do such family-owned companies. For instance, many family companies look primarily, or even exclusively, at cash flow as their north star. Profitability is fundamental, cash is their measure of success and, if they have more cash on hand at the end of the year than at the beginning, it was a successful year.

Private equity firms care less about cash in the short term. Their main concern is growth in enterprise value. They are prepared to take a near-term hit on cash flow in order to maintain a strategic perspective, invest in the business, make acquisitions and take other measures to have a positive impact on a company’s medium- or long-term enterprise value.

The shift in mentality that new investment or institutional ownership can bring to legacy family companies can be seismic when it comes to value creation.

Of course, not all family companies are suitable for such a change. Some companies are what are called “lifestyle businesses.” Frequently located in the lower middle-market, they often have only a handful of customers, lack a unique or proprietary product or distinctive brand name and do not have a dominant position in their market. Often in the business of providing services, they generate cash to support their owners’ lifestyles, are resistant to change and are highly vulnerable to new market entrants, changes in consumer tastes or economic fluctuations.

Family-owned companies that have good potential for benefitting from new investment are not only the opposite by these standards but also have other distinctive qualities. Their business processes are sustainable and repeatable, they have a measure of underlying discipline and they already possess some enterprise value. In some cases, they may just have lost their way, with fatigued management, lack of access to investment capital, too much debt or a decline in discipline and accountability.

Such companies can benefit from new investment on a number of counts. The shift in focus away from cash flow can enable the company to make investments that increase enterprise value. It can put metrics in place to measure against, adopt operationally excellent practices, implement a forward-looking capital structure, become more transaction-oriented and bring in experienced outside talent, both to complement the management team and to bring new perspectives to the board.

These changes can immediately be accretive to performance, further professionalizing management, bringing a strategic approach and imposing operational discipline while opening the capital structure to expansion.

Family companies that previously did not have sufficient access to capital, or had an aversion to re-risking what assets they do possess, now might have the capacity to pursue growth opportunities such as acquisition opportunities. Moreover, private equity or other institutional ownership could benefit some family companies. Competitors that might have been averse to selling off units to a family-owned firm in the same space are more willing to deal with institutional owners, whom they see as less threatening.

Finally, family companies that have new investment are more able to avail themselves of organic growth opportunities. They are able to scale management in order to pursue growth in a way that is impossible in a more limited family company. The access to capital also is vital, enabling them to invest in themselves, make capital expenditures to build new facilities, invest in new product development or R&D, and hire the new staff they need for growth.

No matter what the experts say, nothing ever is truly guaranteed in business. However, one thing that comes close to a guarantee is the potential that new institutional investment can bring to a family-owned company. New resources, new perspectives and new ambitions can rejuvenate even the oldest of family companies, benefitting both the family and the new investors.

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