Traditionally, private equity funds and family businesses have been like water and fire. The private equity funds were the bad guys, said the family businesses and the family businesses were the targets, said the private equity investor. Private equity funds were bad because they snapped up family businesses on the cheap, leveraged them up, and fired staff. They were the Gordon Gekko “Greed is Good” of the business world.
These feelings are probably still around today among some, but it’s a narrow way of looking at the relationship. Why? Because there are ways where the two groups can be partners for growth and wealth creation across generations. These ways might not seem obvious but are an interesting addition to how the two groups could collaborate, particularly in emerging markets.
A partnership can develop in two directions - the family business invites a private equity group as a partner, or a private equity group invites the family business as a partner. After all, private equity funds have specialist expertise and need to put money to work, and families have reputations, market access and might need to take money off the table, because families grow, or they might want to transfer some money to the private side. So, cooperation can be mutually beneficial.
Here’s how they can be partners - with the aid of the accompanying chart below. If you’re a private equity player and have a lot of knowledge of a specific industry and region, but you want to explore opportunities in other markets, like, for example, emerging markets, you will have little or no knowledge about those places and the business dynamics behind. You effectively sit in the lower right-hand side of the chart.
A family can help the private equity firm to be more successful in these markets, for example by helping to internationalise a portfolio company. Ideally, you want to connect capital and execution knowledge of a private equity fund, with the local market insights and a network of a family business. So, this is where a family could be a very worthwhile partner to a fund. Not a limited partner in the traditional sense, but a partner of growth.
A family that’s very strong in their local markets could profit from a partnership with someone who brings in additional capital as well as industry and financial/efficiency expertise, so they can rule their home market even more and potentially go international together. Effectively, through cooperating with a private equity group, a family business can aim to be in the top right-hand corner of our chart - the most advantageous place to be.
Inevitably, relationships between family businesses and private equity funds are likely to grow, especially in emerging markets. Private equity funds are going to be looking more towards emerging markets in the future because economic growth in many of the developed markets is stagnated and interest rates are near to zero. But how much do they know about these markets? They need to cooperate with the leading local players – the reputed and well-connected family businesses - to gain that knowledge.
On the other side, family businesses everywhere, and especially in emerging markets, are facing increasing global pressures and the impact of digital disruption. They have to step up their efforts to compete. Leveraging their strong position in their local market and ruling that market even more through capital and global market access from a private equity fund could be a path to further growth. This doesn’t mean that they have to sell the business - family businesses can give away a minority stake and keep in control of a potentially even larger, more international and more efficient business.
A partnership with a private equity fund can even be linked to succession planning - if succession to the next generation strives for less operational involvement, the family can sell additional parts of the business, and over time maybe even the majority. The relationship can be a step-by-step partnership, where certain goals and preconditions are agreed before greater cooperation happens.
Of course, all this sounds good and there is evidence that an alignment of interest between family businesses and private equity groups can happen along the lines discussed. But often the business models aren’t aligned, e.g. the time periods don’t match - the fund wants a five to seven year time period to realise their objectives, whereas the family wants 20 years or generations.
In this case, how can you build a structure that is aligned? People are trying to do this, but there aren’t any convincing examples of it working yet. That’s because everyone falls back into the logic of general and limited partners, not true long-term partners. So one party always wants to rule the show. In this respect it becomes a classic case of the prisoner’s dilemma - cooperation makes sense, but it’s almost impossible to achieve.
Maybe the long shadow of Gordon Gekko will continue over their relationship for some time yet...
Prof. Dr. Marc-Michael Bergfeld is professor of global family firms at Munich Business School and academic director of the executive MBA program. He is also managing director of the business family advisory boutique, Courage Partners.