Private equity growing trend in family business research and practice

May 23, 2011
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Family business is becoming recognized for the important role it plays in the global economy. And, not surprisingly, West Michigan is becoming recognized as a mecca for family business.

Grand Valley State University and the Family Business Alliance this month hosted more than 100 academic attendees and 140 local family business leaders at the Family Enterprise Research Conference in Grand Rapids. Attendees came from more than a dozen countries, ranging from Finland to Australia, and shared research on a wide range of family business issues.

Creating private equity investments and how they can be used to support the growth and development of family business were important topics of discussion.

Private equity can be useful in a number of ways:

  • It allows family businesses to diversify their investment and business risk.

  • It allows family businesses to improve the competitiveness and support growth.

  • It helps transition from one generation of ownership to the next.

  • It provides a potential exit strategy should it be time to sell the company.

Family businesses in Germany are using private equity to support diversification and reduced business risk by cross equity ownership within family businesses. Through family offices, successful, multi-generational German family businesses are buying minority ownership positions in peer family firms. The interest in this investment strategy has been driven by two issues related to the global recession. First, the problems in banks on Wall Street and large commercial and investment banks in Europe have created a distrust causing families to seek investment opportunities in companies they know and trust.

Second, the recent global recession and its negative effects on firms in industries such as automotive have created interest in diversifying investments in different industries. But, many family companies don’t have excess capital to invest a significant portion of their wealth outside of their own business. Reciprocal investments between two family companies — say one in the auto industry and one in retailing — allows each firm to diversify its investment in other industries while preserving the capital needed to continue to grow both businesses.

The second use of private equity in family businesses is motivated by increasing the pace of business growth. In this case, private equity provides the required capital to expand production, distribution and sales to meet demand growth when it exceeds the creation of internal free cash flows in the business. Also, meeting customers’ evolving needs may require significant investments in technology and product or service development. Improving the competitiveness of a business under changing business conditions requires more than access to new sources of capital. It demands expertise in developing and implementing new technologies and information systems. It may require adding management and professional staff with expertise in finance, accounting, marketing, logistics, international sales or other areas of expertise that the company would have to hire to attain.

Many private equity firms focus their investments on specific industries, which allows them to develop a pool of management talent, business and administrative processes and systems, and relationships with suppliers and customers. For example, private equity firms may have expertise in lean manufacturing or supply chain management that could improve the family business in these areas. Private equity firms are likely to have experience and contacts for making acquisitions and can provide resources for organic growth. The strengths of the private equity group can supplement the management and functional expertise of the family business. Teaming up with private equity also can improve a family business’s cost competitiveness. Operational and administrative efficiencies may result through synergies in functions such as finance, accounting, human resources, logistics and operations. Lastly, private equity investment can result in preserving the family brand and providing career and development opportunities for fa
mily and professional managers as the company continues to grow.

The third use of private equity in family business can support the transition from one generation of family ownership to the next generation. One of the primary issues delaying implementation of succession plans in family businesses is the inability of the next generation to finance the purchase of the company from the retiring generation. As the “now” generation builds the value of a family business, it becomes more difficult for the next generation to save enough capital to support a sale of the company. In many cases, the value of the company is needed to support the retirement of the “now” generation. This is another opportunity for private equity to strengthen and transition a family business for future success. Similar to the dynamics associated with private equity capital supporting growth in family businesses, during an ownership transition the private equity firm can provide capital and professional resources for an ownership and leadership transition between generations.

The fourth use of private equity investment can be a sale of the family business to a private equity firm for strategic purposes. In some cases, this option can provide for the continuation of the family brand, the involvement of family leadership in managing the merged enterprises, and a transition to family ownership in the private equity firm. In the case of a recently sold West Michigan company, the family experienced all these outcomes including a high multiple on the sale of their company to the private equity firm and an appreciated multiple for the capital that was invested in the private equity firm.

The Family Enterprise Research Conference hosted by GVSU and the Family Business Alliance was a great opportunity to showcase many of the successful companies from West Michigan and to learn about significant trends and innovations in managing family businesses that are occurring around the world. The discussions by attendees of FERC show how family businesses are both producing and using private equity to strengthen their businesses and their local, country and global economies.

Paul Mudde is an associate professor of management at Grand Valley State University’s Seidman College of Business and vice president of Rua Associates Merger & Acquisition Services. Randy Rua is president of Rua Associates.

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