When it comes to finance, no family business has the luxury of hoarding cash forever. Time will force the issue. We find that when a family firm reaches the third or fourth generation, it typically runs out of cash and the owners must rethink how to finance the business. Change is thrust upon them.
As the business and the family each get older and bigger, certain things become inevitable: Even with the best of estate planning, the family will have to face death taxes; the business must change and transform; capital will be needed to grow or start new businesses; and very likely, by this time, one or more family members will want to be bought out. All of these monetary matters place great and often conflicting demands on the business for capital, demands that usually exceed a private family business’ financial resources.
Because they want to maintain as much independence as possible, many family businesses we know tend to reject some of the obvious possibilities for raising cash--going public, seeking outside private investors, or taking on an equity or joint venture partner. They also resist the notion of going to the bank and borrowing more money than they’re used to borrowing. Another possibility is to sell part of the business, and while doing so is not unusual, some families just don’t like that option.
The point is, many families have to change their attitudes about financing their businesses–their financing paradigms--to find sources of capital that they haven’t so far needed to find. In doing so, family members may need to stretch beyond their comfort zones as well as their culture. A “no-debt” tradition, for example, just may not work anymore.
One option is to develop a different strategic perspective about your business. Perhaps over time, you change your business so that it becomes less capital intensive. For example, if your business requires enormous sums of capital to build new facilities or purchase new equipment, you might change the business from being one that builds and owns facilities to one that operates facilities that other people own. The Marriott Corporation has done just that. A good operator of hotels, it learned that it didn’t need to own all the hotels it operated. Instead, the company put its highly regarded family name on hotels owned by others and began to make profits from being the operators.
Another family business we know that traditionally used its own capital to finance real estate developments for the family’s own portfolio, began to invite others to invest in specific projects. Construction and property management fees charged to the projects became significant new sources of income.
You may find business growth strategies that require a smaller percentage of capital than you needed in the past--leasing property or equipment instead of buying it, for example, or shifting your business to being less of a manufacturing business and more of a service business. Rather than building a new factory, for example, we know a family business that contracted for the production of an existing Latin American facility.
Families that are very clever, farsighted and successful are aware of the fact that eventually, they are going to need more capital than they have traditionally had access to. We find that they are often very creative in adapting the business or adapting their attitudes toward the business in ways that allow them to get access to new money using different means than they have thought about in the past. Some find ways to use other people’s money without compromising their goals or their interests, and others change themselves culturally to become more comfortable using debt or using partners or selling a part of their business once in a while. They realize that these methods can be the way to keep the business in the family and to keep it thriving.
You don’t want to wait until the third or fourth generation, however, before you acquire the greater financial sophistication that these rapidly changing times demand. A number of financial issues require a family’s attention no matter what stage of business it is in, including looking at your dividend policies and practices and how they affect your company’s ability to be innovative, what financial strategy you should follow in order to change and grow, and where you can secure financial resources for the future. If your company does not already have a thoroughly trained and experienced chief financial officer, it’s time to consider hiring one. Helping family shareholders who are not in the business to understand such concepts as “return on investment” and “debt-to- equity ratios” is also very important. As one third generation CEO told us: “I used to think that arguing over valuation methodologies with my cousins would be my worst nightmare. But it turned out to be a rather stimulating and enlightening discussion.”
Reprinted from Make Change Your Family Business Tradition.