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Family ties

Family-owned firms are the backbone of the European economy, but few seem to want to sell. Javier Loizaga of Mercapital argues that if investors work hard to find deals and partner with owners, the rewards justify the effort.

Their share of GDP may be falling, but family-owned businesses play a huge role in the European economy. Despite the rapid globalisation of the economy, they are - and will remain - the cradle of entrepreneurship in most of the continent.

The proportion of family-owned companies in Spain is far higher than in most European countries. Today's corporate landscape is a product of history. Spain has experienced 20 years of spectacular economic and social growth and transformation, after four decades as a closed economy and four centuries of relative isolation.

Corporate Spain was born in the forties and fifties. The country's hundreds of family-owned businesses are now mostly being run by first or second-generation founders. They are small, focused on their domestic market and have little exports or foreign presence. Hundred-year-old companies, large or multinational family-owned firms, conglomerates and diversified businesses are all scarcer in Spain than its European neighbours.

This is why family-owned businesses will remain the largest source of deals in Spain. But as the economy grows and converges with Europe, the focus is on growth capital transactions rather than buy-outs - which, although growing steadily, are not proving to be the fertile source of deals many predicted.
At this point in Spain's history - in an environment of relative underdevelopment, rapid economic growth and a generational shift - the biggest opportunity for private equity fund managers lies in finding, supporting and nurturing these medium-sized family-owned businesses. Finding a suitable business that you can enter, live with, and extract a return from can be a costly process. However, investors can find better pricing structures and greater opportunities for change - the biggest and ultimate source of returns in private equity. Domestic and international private equity firms will need to pay this price if they are to succeed.

Doing deals with family-owned companies can be both challenging and exciting - and very different to working with big corporates. This is most pronounced with growing businesses, often affected by the different objectives and expectations of various family members working in the same company. As Montaigne, the sixteenth century French moralist and essayist, said: “Il n'y a guère moins de tourment au gouvernement d'une famille que d'un état entire.” Roughly translated: “There is scarcely any less bother in the running of a family than in that of an entire state.”

Targeting smaller family-owned companies has implications for sourcing, executing and closing, monitoring and partnering, and exiting from deals. Traditional channels, intermediaries and prescriptors are less use as sources of deals with family-owned companies. They rely more on trust, word of mouth, relationships and reputation among peers.

It is not easy for a private equity house to operate in this environment. Having the available funds to invest or forge intimate relationships with investment banks is not enough. Global brands are also less valuable. The investor needs a larger and more capillary network, and must give a bigger role to non-professional agents of all kinds. Overall, the cost of sourcing deals from family-owned companies is higher, in terms of the breadth and depth of the team and the longer fermentation period.

When executing and closing a deal with a family vendor, the buyer must be prepared for a more emotional negotiation. If the family is selling its business, tax implications can entirely drive valuation discussions, whereas a family staying in the company will often put an emotional surcharge on the company it founded and has run for decades.

Sometimes this gap can be bridged with dynamic pricing mechanisms, such as earn-outs. If the family is not fully exiting, the private equity manager will have to become the family's “partner” on all levels, sharing common views on the business and its value. Getting majority stakes is harder in these situations, but need not be necessary if business plan targets and exit strategies are agreed upfront.

In minority situations, it is even more important to establish clear rules for life together early on, including company objectives going forward. Family-owned companies are quite likely to want more than just money from their investors. They are often attracted by industry expertise or operating and strategic experience. Making sure there is a meeting of minds on most key aspects of the business plan can save many headaches and hours of fruitless discussion.
A family welcoming a financial partner has already bought the need for outstanding, professional and properly incentivised management. But personal chemistry is still paramount. It can be a long, uncertain and not always happy life together until that realisation. Divorce plans should be made in advance, just in case the relationship does not work. This ensures that parting without a great loss of value is at least possible.

One specific issue also needs careful and objective consideration: the judging or evaluating of family members with management positions in the company. It is not always necessary to remove some or all of them - after all, they steered the company to the point where an investor found it interesting.

If the family has not yet sold, planning and agreeing on how and when to exit can be the biggest challenge. The approach will be very different according to whether the family wants to stay on when the private equity cycle of the business plan comes to fruition or wishes to realise its stake at maturity. Younger generations of family dynasties increasingly have a capitalistic view on wealth creation - maximise and realise the value at some point. This makes it easier for investors to benefit from the vision and stamina these family-owned companies have.

As a famous British stateswoman once said: “There is no such thing as Society. There are individual men and women, and there are families.”

Javier Loizaga is an executive partner at Madrid-based private equity firm Mercapital. He can be contacted by email on jlj@mercapital.com

This article appeared in Real Deals on 11 November 2003. For further information please visit www.realdeals.eu.com.

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