Private Equity Challenges in Family Businesses

Most family owned businesses survive through the ingenuity, hard work, and resourcefulness of the founder(s) in the first generation. As the founders grow older and the business hits certain barriers to growth, often there is a need for a capital infusion to satisfy the goals of the founders and the other stakeholders in the continued growth and success of the business. Private equity, while a viable option for many privately owned businesses, can be perceived as a solution that is unworkable for the typical family owned business because of the fear of loss of control. In an article last year in the Journal of Family Business Strategy (Volume 3, Issue 1, Pages 38-51, March, 2012), authors Florian Tappeiner, Carole Howorth, Ann-Kristin Achleitner, and Stephanie Schraml describe some research they performed on a group of family firms in Germany. The research focused on issues these firms faced in soliciting private equity investment. Excerpts are provided below, along with a diagram, and accompanied by some commentary:

Under the pecking order hypothesis, private equity is a finance of last resort. Tests of the pecking order and its assumptions have provided conflicting results. For family firms, the pecking order hypothesis is incomplete because it ignores family effects. Case studies of 21 large family firms in Germany are analysed. Testable propositions are derived. Family firm owners balanced financial and non-financial resources of private equity with the need to cede control rights. Non-financial resources were valued more highly when resolving family issues. The observed pecking order was driven by control rights. Important implications for family firms and investors are discussed.

The authors articulate that private equity is perceived as a final option for owners of family businesses. No surprise there. Control is seen as the most important factor in determining what outside resources to enlist. Private equity is seen as less widely used than non-financial resources when the goal is to resolve family issues.

Family and business influences are equally important in terms of the demand for private equity in large family owned firms. Private equity was sought out for reasons that included the exit of a sibling, parents’ wealth diversification and business growth. The authors note an “interdependence of demand and supply in financing decisions, most noticeably in the negotiation of control rights, which featured strongly in the interviews. (Sometimes the underpinning reason for seeking an investor was to consolidate control, for example, buying out a family member with conflicting views or concentrating ownership in one branch of the family, which, it was argued, would free up decision making within the family firms.)”PE Finance in Family Firms

Minority private equity investments provided study participants with needed finance while allowing the family owners to maintain family control. Private equity also provides managerial resources. The presence of outside money and potential ensuing leverage in executive decision making illustrates the potential for better corporate governance practices and enhanced expertise to pursue business opportunities, such as IPOs or globalization. Said the authors, “Firms with family issues may value the non-financial resources that private equity investors may provide. In particular, family firms wishing to reduce family conflicts may value the neutral or professional role of a private equity investor.”

It was noted that business performance issues led to loss of control in two of the family firms receiving private equity infusions. Still others negotiated control rights guidelines aggressively because of their concerns over the potential of such an occurrence. The investors, for their part, acknowledged that dealing with family firms presented a unique set of challenges usually not experienced in other deals.

Sell Your Business Even if Others Can’t

In reading about the issues facing small businesses in the United States since the recession began in late 2007, I have heard about many sectors that have fallen behind historical performance levels. One that I hadn’t considered very much until this week is what is called the “business-for-sale” sector, which has seen a huge drop-off in comparison to all metrics known prior to the recession. While many have spoken about the large amount of private equity not in circulation, many of the reasons it is being withheld translate to other types of business buyers.

Whether you are representing an equity firm or your own personal business interests, it is likely that you have been trying to figure out when the economy may turn around. In classic business theory, it would be ideal to buy at a deflated price right before the economy picked up so that your investment could piggyback onto the general trend of successful recovery. Such market timing could make your investment produce very high–perhaps unprecedented–returns.

Since the economy appears to have stabilized, though not surged forward in a demonstrable way, what are these people who would otherwise be buying small businesses thinking? Observers of the business-for-sale sector wonder when they will see a positive change. They are anxious to see more acquisition activity.Buy sell dice

Hindrances to Business Sales

Whether you listen to political pundits, talk show hosts, or economists, all would concur (at least publicly) that small business is key to the overall recovery. Yet, if small businesses are not churning ownership, it is hard for them to obtain the necessary working capital to fund growth and operations. conducted a survey of 260 business brokers from around the country to attempt to determine whether market conditions were improving. A whopping 70 percent indicated that financing for business acquisitions has not improved since 2011. These findings and percentages are consistent with survey results from last year, showing a trend of stagnation.

With commercial loans harder to come by (according to the survey), many buyers can’t get the financing they need to do deals.  Business brokers say that banks have made the loan process even more difficult in 2012, decreasing the chances thereby that buyers will begin investing in businesses for sale. Mike Handelsman, group general manager for and, reports that borrowing is particularly difficult for new or young entrepreneurs. Since banks and similar entities have taken the position that a track record of success is one of the top determinants of future success, newcomers to the small business arena–either startups or acquirers–are handcuffed. 

Handelsman cited other factors of concern to business brokers from the survey. Concerns about the U.S. national debt,  political deadlock (re: the fiscal cliff), long-term unemployment and small business/personal tax rates (14%) also appear to diminish buyer confidence. However, he did offer some tips for sellers:

Seller financing is not necessarily the right strategy for all business succession scenarios. But under the right circumstances, a seller’s willingness to finance a portion of the sale can dramatically increase the number of potential buyers and create more advantageous sales terms (e.g. a higher sale price). Sellers also need to plan for the sale, and make their businesses as attractive as possible to buyers.

Here are a few ways to plan for the sale and make your business attractive–

  • Install an outside board of directors, with positions filled by non-competing entrepreneurs rather than the typical CPA, attorney, banker, and family friend.
  • Stop paying executive perks out of business accounts–clear separation will help show your commitment to professional management.
  • Document the tasks and procedures performed by the executive team. When it has been documented, the business is worth far more money because it is no longer dependent on the personalities.
  • Have a CPA review your financial statements–audit if you can afford it–especially if you have never had it done before.
  • Work with a transactions attorney to advise on deal structure and terms so that you can think through tax implications that may cause you to accept certain types of offers.

Chin up! If you follow these best practices, you will be one of the first ones to sell your business, regardless of whether many others sell theirs at the same time.



Do Your Cultural Diligence in M&A!

Of course the merger was a success. Neither company could have lost that much money on its own.

-Steve Case, Former Chairman of the Board
AOL/Time Warner

Competitive markets create an environment wherein companies strive for revenue growth. When organic (internal) growth is hard to come by, inorganic growth becomes a target. Inorganic is a category that includes merger and acquisition (M&A) activity as a primary strategy.

While business exigencies demonstrate the “need” for change, often the hard facts found in classic due diligence processes have far less to do with ultimate success than the cultural fit of a transaction between parties. Consequently, organizations that understand their core values are much more likely to reach the kind of growth and success that nearly all businesses seek [Gallangher 2003].

Successful M&A has been known to grow markets, build on complementary strengths, and eliminate inefficiency. But what ultimately matters in an acquisition is what happens in the hearts and minds of the people who remain with the new organization and what culture these formerly distinct entities choose to build while moving forward [Gallangher].

The Mercer Consulting Group, in studying M&A activity, finds that, among unsuccessful ones that many of the failures are caused by not conducting the same kind of “due diligence” on the culture, structure, and processes of an acquisition target as they do on the financial balance sheet [Gallangher]. 

Traditional due diligence typically analyzes the following:
– Historical performance,
– Ownership and organizational structure,
– Management team,
– Products and services, 
– Assets and liabilities,
– Information systems and technology, and
– Organizational culture [Bouchard, Pellet 2002].

J. Robert Carleton, management consultant and senior partner of the Vector Group, says, “Unfortunately, little or no time is generally spent analyzing the nature, demeanor, and beliefs of the people who will be involved in carrying out the business plan”. He believes that standard due diligence does not address some of the key questions that must be asked to accurately assess organizational readiness for a major change, such as a merger or acquisition. Even when some of the “right” questions are asked, Carleton argues, they are often limited to brief interviews with key executives, who likely have differing views from the rest of the employee group. The people in the trenches, the ones doing much of the actual work are not even involved. He  finds it interesting that “in financial and legal due diligence no such ‘act of faith’ is acceptable” in terms of the investigative procedure [Bouchard, Pellet].

“Cultural due diligence” is a phrase that more strategists are using  to assess what stumbling blocks may hinder successful integration of entities and their operations. Key factors to be considered include:

– leadership and management practices, styles, and relationships,
– governing principles,
– formal procedures,
– informal practices,
– employee satisfaction,
– customer satisfaction,
– key business drivers,
– organizational characteristics,
– perceptions and expectations, and
– how the work gets done in your organization

[Bouchard, Pellet; see also Carleton, Lineberry 2004].

When HP and Compaq decided to combine forces, they used schematics like the one below to help them discuss the salient issues–

After looking through these issues and discussing each company’s culture, the merger team put together a chart like the one below to begin developing tactics to plan for a smooth post-closing integration.

As you look at this chart, think about key M&A transactions in your industry or local community. Of the ones that did not pan out as planned, do you think they would have stood a better chance had they systematically worked through these type issues during due diligence?

Cultural due diligence is vital to successful M&A processes. If earnest consideration were given to culture as it is to financial and other factors, inorganic growth and increased market share would be a realized outcome far more often!

(Thanks go out to Agata Stachowicz-Stanusch, who wrote of the value of cultural due dilgence and detailed a case study of the HP-Compaq merger in the Journal of Intercultural Management’s April, 2009 edition.)

Simple Stories Make Great Pitches


ABC’s hit show, Shark Tank, is one of my very favorites on TV. It attracts entrepreneurs of all ages, levels of experience, and backgrounds to come pitch their business idea for angel investment by one or more of the sharks. One of the young ‘treps who pitched this past year is Joseph Draschil, co-founder of  Draschil is currently participating in Start-Up Chile (written about here a few months ago) while enrolled in an MBA entrepreneurship program at Babson College. 

His first major assignment in a Babson course was to create an opportunity storyboard for a business idea, limited to a single PowerPoint slide. The storyboard became a rocket pitch: a three minute, three slide, live pitch in front of his professor and classmates in the entrepreneurship class. Draschil was then encouraged to enter the Babson Rocket Pitch event, to pitch his idea in front of investors, professors, members of the community and the student body.

The following week, his team entered the Big Idea Competition, for which they were required us to upload a three-minute pitch video to YouTube, secure the most “likes” and move to the finalist round to pitch on stage for three judges. Within one week of being named one of two winning teams, Draschil received an e-mail from the director of the entrepreneurship center at Babson. Two of the “sharks” were to visit the school and hear the pitch. Here’s the young entrepreneur’s perspective on the experience:

Although I was terrified of failing in front of entrepreneur celebrities and all of Babson, I committed to participate and the pitch went great. My partner and I stumbled a couple of times during the Q&A session, but that’s okay. You make mistakes, learn from them, and improve — that’s the essence of the startup journey. After the event, Mark Cuban mentioned to us that he believed if we could get the marketing down, we would kill it.

While I continue to work on the business, I have learned a few key lessons about creating a dynamic pitch:

  1. Be visual. Please, no slides full of bullet points. Use simple and clean images that clarify and complement what you’re saying — not complicate it. When slides are cluttered and busy, the audience will be focused on deciphering them instead of focusing on you. Don’t forget that for most investors, the entrepreneur is more important than the product or idea being pitched.
  2. Tell a story. Storytelling lies at the heart of who we are as humans. Remember, you are not a court lawyer trying to amass evidence for the jury as to why your idea is destined to make millions. If your pitch is just a crowd of facts, figures and pie charts, you may lose your audience.
  3. Practice, practice, practice. Get in front of others and pitch — a lot. Don’t worry about your pitch being bad the first few times you do it. It most definitely will be. As you practice, though, you will learn which parts your audience is responding to and which parts need to be adjusted. Over time, your confidence and delivery will improve.

These 3 lessons are important for any entrepreneur. Pay attention to Draschil’s advice to be simple & clear in your slides. Way too much information in the presentations of many. The difference between an engaged audience and a bored one is your ability to weave a compelling story. Finally, the admonition to practice is so practical, fundamental, and predictive of one’s likelihood of success.

Add Value to Your Privately Owned Business

Most corporate governance articles, presentations, and conferences are focused on publicly owned businesses. With corporate and executive scandals galore occurring over the past few years, there have been outcries for better controls, systems, and oversight guidelines. Yet, the same emphasis and attention is grossly lacking in the privately owned business community. One of the areas in which governance best practices could be applied is in the realm of mergers and acquisitions. Nick Miller of Clayton Utz law firm in Australia offers some insights below for this unique situation:

Increasing the level of formal governance can assist in reducing risk, identifying issues that might emerge upon a sale and generally enhancing the credibility with which the business presents itself to potential buyers. Perhaps even more powerfully, governance is a means by which, both in fact and in perception, a business can present as less dependent on the involvement of its founders than it would without governance. This can add very significantly to value.

Many private business owners think that the absence of governance procedures makes them more flexible, more adaptable and more opportunistic. That may be so, but the benefits of that should be weighed against the benefits of formal governance when planning a sale. 

There are a range of ways to adopt some greater formality in governance:

  • without changing the make up of the board of a company, the company could implement a more structured system of monthly meetings. These may or may not be formal board meetings, but should nonetheless involve the directors and those who report into the CEO;
  • a company can set up one or more committees. These can be formal board committees or more informal, but they are set up to address areas of need, to bring in expertise and focus on how risk management can be improved and issues for the business addressed. Examples are an audit and risk committee, a brand development committee and an employee policies committee, to assist in developing those aspects of the business in readiness for sale. These committees might have outsiders on them and they might not, depending upon the need and the expertise available in the business;
  • an advisory board could be established. Properly structured, members of an advisory board will not carry director duties and liabilities and this can be a sensible stepping stone towards a more fully independent board;
  • one or more outsiders can be brought onto the board. This can be very beneficial, but it needs to be right for the business; and
  • governance can also be improved by developing appropriate governance policies and procedures.

Corporate buyers and private equity see many poorly organised privately‑owned businesses. They will take the opportunity to highlight the possible risks to them in undertaking an acquisition of a poorly organized or more risky business. Some investment in governance can dispel most of these apprehensions, and allow private business owners to defend the level of risk in the business and so achieve higher value for a seller. Nonetheless, formal governance should be introduced carefully, to ensure the owner’s ability to drive and control the business is not unduly impeded.

In summary, shareholder value is enhanced in privately owned businesses through better corporate governance. Opinions of value are enhanced by checks and balances, independent processes, and a decreased dependence on the founder(s). Make the necessary adjustments to your business. You will make better decisions, increase the market value of the business, and create an environment wherein others can grow in their roles and responsibilities.