Survey shows how private equity can help family businesses

Private equity and bridge the gap between the family business model and better performance, says INSEAD   Photo: Pixabay

Private equity and bridge the gap between the family business model and better performance, says INSEAD   Photo: Pixabay

Despite an often fraught history between the two, private equity working with family businesses can improve performance, says new research.

According to the report from the business school INSEAD, capital and expertise from a private equity firm can help address challenges often found at family businesses. In this respect, the report highlighted a successful partnership between the two with an example of a family business in the logistics sector in Southeast Asia, which brought in a private equity investor. “Immediately following the private equity firm’s minority investment in the business, the company’s founder and the private equity firm initiated a series of concrete steps to improve the performance of the business,” says the research.

Part of the success of the move was down to the greater professionalisation of the company’s governance structures, says the report. A professional board was installed, which separated the chairman and CEO position, as well as bringing in an independent director. “The management team was also expanded so that the owner could spend more of his energy focusing on business strategy rather than the day-to-day decision making that frequently took up all of his time. The private equity firm drew on its network and helped recruit these managers,” says the research.

The report added: “At the advice of its private equity partner, the company invested heavily to exploit the booming demand for logistics services, expanding its trucking fleet by four times in a two-year period and diversifying into storage with the construction of an integrated warehouse facility. To drive new business, the firm professionalised and expanded its sales team, training them to sell services across the value chain. These initiatives have translated into a rapid growth in sales volume and revenue as well as a 10-fold increase in employee headcount.”

Although the study shows how private equity can be useful for family businesses, the two haven’t necessarily been best of buddies in the past. The negative image of private equity firms as short-term asset strippers didn’t endear the sector to the patience capital ethos of many family businesses.

Nevertheless, recent moves by many private equity firms to soften their image and to be more inclined to take a longer-term approach to investing have helped to bring the two closer together. And this report highlights this development.

The INSEAD report surveyed 123 family businesses in Asia-Pacific and the Middle East. And among its other finding was the significant jump in the institutionalisation between first- to third-generation family firms and fourth-generation firms and beyond. “Outperformance of a subset of these family firms – the ‘champions’ – underscores how introducing formal policies, procedures and professional best practice supports leading family firms’ operations and long-term health,” says the research.

The chart from the INSEAD study below helps to illustrate the point about how the institutionalisation between the various generations of family ownership increases with more generations of control.  Each bar in the graphs shows the average institutionalisation score of the survey participants by generation. The different colour segments of each bar representing the contribution to the total score of the six attributes in the index below the chart measured. The research combined first-, second- and third-generation family firms (“ascendants”) and fourth-generation and beyond (“champions”) into two groups

Source: THE INSTITUTIONALIZATION OF FAMILY FIRMS From Asia-Pacific to the Middle East, INSEAD

Source: THE INSTITUTIONALIZATION OF FAMILY FIRMS From Asia-Pacific to the Middle East, INSEAD

The research saw the factors as causing the proficiency gap between the various generation ownership categories as the following:

  • Professional boards: 34% of ascendants didn’t have a board and 21% had a board consisting only of family members. Champions were twice as likely to have boards with independent directors and appropriate sub-committees.
  • External capital: 55% of champions had a public market listing vs.18% of ascendants. Champions were also more likely to have raised equity capital from external investors, including private equity funds, strategic investors and high net worth individuals.
  • Monitoring and information systems: Champions monitored Key Performance Indicators every month on average – vs. quarterly for the ascendants – and leveraged enterprise resource planning systems more frequently. For example, 64% of champions used a customer relationship management tool vs. 31% of ascendants.
  • M&A: 55% of champions had in-house corporate/M&A departments vs. 23% of ascendants. Champions were more than twice as likely to have completed an M&A transaction.
  • Relationships and conflict resolution: Champions had more established relationships with government officials and other business families, and had formal conflict resolution mechanisms in place to diffuse disagreement over the direction of the family and the business.