Managing and Financing Growth © Belén Villalonga, 2015 Stern School of Business, New York University bvillalonga@nyu.edu 1. Growth in family businesses v. in non-­‐family businesses • Growth is generally perceived as good for businesses, often necessary to maintain competitiveness • In family businesses, growth is just as desirable, and often more necessary than in other types of businesses, to (1) keep up with the family’s own growth, and (2) keep the business within the family • The three key groups of participants in a family business system—the family, business and its owners—all stand to benefit from firm growth • However, growth also raises special challenges for these businesses, and requires sacrifices from each of these three groups 2. Fundamental tradeoffs in family business growth • Founders and their families tend to have a strong preference for retaining control of their companies, due to economic and psychological reasons—
particularly those family shareholders who are also managers. These family members would rather reinvest as much as possible of the firm’s earnings into the firm and not share control with either equity or debt holders. This often results in letting go of valuable growth opportunities, e.g. acquisitions that could be financed with firm stock • On the other hand, other family members (often those who don’t work at the firm and/or are not part of the controlling branch) would rather the firm pay a high dividend—which may be the only way for them to get any return on their investment —or reinvest in growth—if they have a way to eventually realize those capital gains. Thus, they may favor giving up some equity control to finance growth or liquidity 3. Benefits and costs of outside capital for family firms • For privately held family firms, getting outside capital is a way to finance growth and provide liquidity to shareholders, but it comes at the expense of some loss of control. Outside capital may be provided by a private equity firm, by a strategic partner in a joint venture or any other form of strategic alliance involving an equity investment, or by public investors 1 •
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Outside capital providers can also bring about additional benefits to family firms such as professionalizing and increasing the accountability of the firm’s board and/or management team. On the other hand, this greater professionalization and accountability, while beneficial for the firm’s overall efficiency and for the family as shareholders, can be costly for the family on other dimensions, such as job losses for certain family members, or the need to draw a clear line between the family’s personal and corporate finances Which of these alternatives is best for a given family firm is contingent on the situation but there are some general benefits and costs to each alternative beyond these common ones 4. Benefits and costs of private equity partners for family firms • Private equity partners have the advantage of being active, capable, committed owners. They also tend to professionalize the firm and its board, and often allows the family CEO to devote more time / weight to business issues and less to family issues • On the other hand, private equity firms have a shorter-­‐term orientation than family shareholders and will eventually have to exit the investment , so they can only be a source of temporary capital • The Spyder Active Sports, Inc.–2004 case (HBS 206-­‐027) illustrates some of these the benefits and costs 5. Benefits and costs of strategic or joint venture partners for family firms • Strategic partners are corporate investors that are in the same or a related industry and are typically larger than the family firm involved. These investors can add enormous value to a family firm through their technology, know-­‐how, global reputation and experience, and their relationships with customers and suppliers • On the other hand, the loss of control they bring about for the family is often larger than for other outside capital providers, as they are rarely willing to come in as minority partners, and are more likely to integrate the family firm’s operation and culture into their own • The SUN Brewing (A) and (B) cases (HBS 207-­‐022 and 207-­‐039) illustrate some of the benefits and costs that a strategic partner can bring to a family firm 6. Benefits and costs of taking the family business public • Public equity’s benefits include financial flexibility (present and future), the creation of more powerful incentives for managers and employees (which enhances the firm’s ability to recruit and retain talent), the possibility of using 2 •
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the firm’s stock as a currency to finance acquisitions, and the increase of the company’s visibility to consumers. In addition, the loss of family control can be smaller than for other outside capital options (possible sale of minority equity stakes, non-­‐family owners are disperse) On the other hand, public equity also carries with it costs such as short-­‐termism, and the requirement to disclose information that can be valuable to competitors and is costly to produce in terms of money and managers’ time. Moreover, the process of raising public equity can be very costly. Two HBS cases illustrate in a contrasting fashion the benefits and costs for family firms of partnering with public investors: Ayala Corp. (HBS 207-­‐041) and Kohler Co. (A) (HBS 205-­‐034). 7. Relinquishing ownership but not control • Families can retain control after going public or receiving outside capital, through various “control-­‐enhancing mechanisms”: 1. Dual-­‐class stock (two or more classes of common stock with different voting rights) 2. Pyramids (indirect ownership that creates a separation between economic interest and control) 3. Voting agreements (whereby voting power is transferred from one shareholder to another) 4. Disproportionate board representation (fraction of board elected by family exceeds their voting control) • These control-­‐enhancing mechanisms allowing the company to access capital without losing control of the business, and can be used to accommodate diverging preferences among shareholders regarding liquidity and control • However, they often come at a cost, since in many stock markets around the world, companies with these mechanisms trade at a discount relative to comparable companies without such structures 3