How do your lenders see your company?

By Robert F. Mancuso

Family firms are often considered risk-prone. To protect your company in times of fiscal crisis, know the risks and avoid them.

I was recently approached by the wife of an acquaintance, who told me a very sad story. Her husband, who had inherited the presidency of a third-generation family business and for years had succeeded in building the company, now found himself near bankruptcy. The origin of the problem was a dispute with a former offshore partner who had sourced raw materials for their family’s company. The dispute grew larger and larger and consumed million of dollars in legal fees.

The husband had personally guaranteed the company’s bank loans. With the interruption in the shipment of new materials, the business couldn’t deliver finished goods to its U.S.-based customers. The firm lost millions of dollars in revenues and quickly defaulted on the loans.

The company couldn’t meet the payroll for its 100 employees and eventually closed its factory. The banks seized the business assets, threatening to sell them and then call on the personal guarantees. The business had always been the family’s largest asset; their personal assets were insufficient to pay off the company’s debts, and the family faced bankruptcy. The woman asked if I would lend the family money so they could pursue a lawsuit against their former partner.

After asking her several questions, I discovered that although her husband had led the company for many years, she understood very little about the business. I offered to meet her husband to determine if I could help. He never called. Eventually I heard the family had been forced to sell almost all their assets, including their two homes, art, furniture and jewels, to satisfy the personal guarantees on the bank loans. Their son had to abandon his chosen field and join the company as an unpaid consultant. The husband and wife moved into a one-bedroom apartment to start over as they each approached age 60 with no assets, a terrible credit rating and no livelihood.

This sad story illustrates why family-held companies are often more vulnerable than their owners ever suspect when a financial crisis hits.

Understand the risks

Family companies tend to assume structural and operational risks that make a financial crisis much more devastating when it occurs. During periods of tight credit, family companies are less likely to secure financing and more likely to develop a liquidity-induced crisis.

Family business owners who know the risks they face are in a better position to protect themselves in times of fiscal stress.

Risk No. 1: Banks tend to view privately held family firms as more risky than comparably sized public companies. Why? These companies’ financial statements are not always audited, and “reviewed” statements are often considered unreliable. As a result, banks demand additional collateral or security, which typically means a personal guarantee of a portion of the loan by the major shareholder(s). Many banks also take a security interest in a company’s inventory and receivables.

In normal times, banks view family businesses as manageable risks. When credit is tight, many banks avoid lending to these companies. If they renew an existing line of credit, it might be on more restrictive terms—shortening the maturity, reducing advance rates, demanding that a higher percentage of the loan be supported by additional personal guarantees, increasing the interest rate charged or requiring a co-lender.

Family business shareholders must accept these facts and structure their capitalization accordingly. They might consider tapping other sources of capital, like mezzanine funds and private equity. Another alternative is divesting non-essential assets to increase liquidity and prepaying bank loans with the proceeds of asset sales. Family business managers also should examine all capital expenditures, especially in assets located outside the bank’s reach—such as foreign subsidiaries, for which a domestic bank gives no credit.

Risk No. 2: Many family companies are poorly governed, leading to inadequate sharing of information. Both these characteristics arise from secrecy and distrust for outsiders.

In today’s highly competitive world, customers need to know about their suppliers, and vice versa. Particularly during hard economic times, a refusal to let your key suppliers know anything about your financial affairs will only encourage them to suspect the worst. That could lead to a tightening of vendor credit, compounding other problems.

Further, families who practice excessive secrecy suffer when problems arise because too few people know how to unlock all the gates that exist between the critical information and a solution. If you don’t have a board, create one. If you have one, make it stronger and more effective by adding outsiders who will question and challenge the CEO’s and CFO’s decisions.

Risk No. 3: Many family companies promote based on bloodline rather than merit. While sub-par performance might be overlooked in good times, merit must rule the day when the economic outlook is poor.

In a tough economic climate, lenders are under enormous pressure to scale back their commitments to all but the most important and best customers. Every decision a borrower makes must be scrutinized from the perspective of “how will it look to our bank?” A bank will consider actions taken by a borrower when determining whether to renew an existing line of credit. Promoting an individual into a key position because of bloodline rather than accomplishment casts doubt on the standards a company applies in building its business.

Risk No. 4: Many family-held companies view their lenders as the enemy when performance falls short of budget. The CEO often instructs staff to “Tell the bank loan officer as little as you can.” Sharing information, rather than stonewalling and hoping the problem will go away, will usually enhance the debtor-creditor relationship.

Adapt to a changing climate

Family business owners who understand how their lenders view them will be prepared to adjust to changes in lending practices when a financial crisis hits. Banks can’t abandon all their family business clients—and you want to be one they keep.

Family business leaders who adopt better governance practices and accept criticism from qualified outsiders will reduce many potential risks and create some distance between company debts and personal assets. In so doing they will help prevent a company crisis from becoming a family crisis.

Robert F. Mancuso is founder and managing partner of the Dellacorte Group, a middle-market private equity and financial advisory firm (

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Autumn 2010

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