Families looking for innovative financing

When it comes to financing growth at a family business, traditional methods have always been favoured. That means paying for it out of savings, either from retained earnings in the business, or from members of the family. 

Debt was the least favoured option and when it was used normally it comprised of a straightforward loan from a trusted bank. More risky forms of finance from groups like global investment banks and private equity were never going to be considered. 

But are family businesses beginning to get more ambitious with how they finance growth? A study of US family businesses from EY suggests they still prefer traditional ways of financing their businesses, with 61% of family businesses in 2012 financed their growth by traditional bank loans, compared with just 36% of all companies. And 58% of family businesses said they reinvested retained earnings, compared with the overall figure of 50%.

Despite their built-in conservatism family businesses are looking to new ways to raise money, or at least the more adventurous among them are. That may be because of external factors like greater competitive forces and the need to expand outside of their core market to remain competitive. 

Another professional services group, KPMG, found that family businesses are looking to finance expansion through external sources, but are finding it difficult to do so. According to a recent study from the group, more than a third of family businesses claim that the current economic climate has significantly affected their ability to finance projects via bank loans. This has, according to KPMG, intensified the hunt for alternative sources of finance.

Family businesses are also looking to manage their risk better than in the past, which can mean being more creative with the debt they do have, particularly in a low interest rate environment.

As they tentatively look at less traditional ways of financing growth, family businesses are also seeing banks or investors more likely to tailor their loans, or investments on favourable terms.

“Families want to preserve their control and avoid external monitoring, which can be inconsistent with a private equity or venture capital partner,” says Carrie Hall, a partner at EY and family business leader for the Americas. 

“But family businesses are increasingly attractive to investors and they have modified their models to adapt for the families.” 

The financial sector, or at least parts of it, appears to be coming around to the longer-term growth mentality of family businesses. “Their stability is fashionable these days,” says Hall. 

Investment groups like Lindsay Goldberg in New York and Alaris Royalty Capital in Canada are tailor-making their investing strategies to suit family businesses. “Our structure was really made for family businesses – businesses that are never for sale,” says Steve King, chief executive of Alaris.

King says that Alaris works by taking investing back to its basics by emphasizing dividends. “We are generating returns strictly by way of dividends. Unlike private equity, we don’t need to return our capital to anyone. This means we can stay with a family or entrepreneur as long as they want, and if that’s 50 years that’s absolutely fine.”

It’s hardly surprising that this long-term approach to investing is attracting considerable interest from family businesses across North America. King says Alaris typically look at businesses with earnings of between $10m to $50m.

“We are passive investors. Who are we to tell them how to run their business?”

King adds that raising funds to invest in family businesses. “It’s what much of the investment public want – low volatility yield.” Returns for investors typically are around 15 to 16% annually. “That may be less than private equity, but it’s a lot less risky,” he says.