OPINION: Think like a private equity owner

By Rodney Goldstein, Susan Lucas

Build on the inherent strengths of your family business

You own a thriving business — it could generate $50 million, $500 million or $5 billion in revenues. Managing growth may be more challenging as the business gets larger. With success may come concerns about estate concentration, planning and taxes. Perhaps you’re concerned about who will run the business in the future or how you can meld the right family-member executives with non-family talent. You want to ensure the business continues to prosper and stays true to your values and goals. You know you should evolve governance to provide oversight after your active career chapter. Most of all, you want your family to own your company for the long term.

You’ve observed private equity firms’ or competitors’ offers to buy similar companies. You may even have been approached to sell. Your financial advisers are urging you to diversify your assets.

The alternative to selling — sustaining as owners while embracing practices of the best value-adding private equity investors — can prove more rewarding. But you must adapt those practices to your own advantages. You have experience, reputational value and deep expertise; plus, you can play for the long term, unfettered by the short-termism intrinsic to private equity funds. You can make intergenerational family ownership a competitive asset. Beyond financial advantages — including efficient tax and estate planning, as well as the remarkable power of compounding — sustained ownership of your business can be a unique vehicle for perpetuating your family’s culture, identity, and values. These are not private equity firms’ mandates.

To have a truly indefinite ownership horizon, your company must sustain its competitive and financial success, as well as ownership stability. This is hard to do.

Properly implemented, specific private equity practices can build on your inherent strengths, improve governance, attract and retain talent, and build operational and financial resilience, all enhancing your odds of succeeding at “the long game.”

Strengths of the Private Equity Fund Model

To drive value creation in the companies they acquire, the best PE firms deploy professional governance and management oversight strategies. Implicit in their success, especially when buying family-owned businesses, is that they buy companies that haven’t already optimized their potential. 

What are these strategies and tools, and how can you apply them to strengthen your company?

  • Articulate and adopt a vision. The company’s owners/principals must articulate a vision for ownership. Here’s one you might consider: to own for an indefinite horizon and to play the long game, seeking long-term growth in competitive position, size, profitability, value and reputation, articulated in a tax-smart manner. As a family-owned company, you may want to add commitments to at least three constituencies: 1) employees, customers and channel partners; 2) communities in which the business operates; and 3) the family shareholders. The final vision can be shared with all stakeholders and provides sorting criteria to shape priorities and inform choices.
  • Have a high-functioning board. This is a first principle in private equity: a true, fiduciary (not advisory) board. Boards can be small –  five to seven or so members. Board construction done well will consider both near-term requirements and preparation for later, with an eye for when “later” might show up. A high-functioning board will require the company’s executive leadership — family and non-family — periodically to self-assess: How are they performing relative to agreed annual and intermediate-term plans and objectives?

Boards of directors for family businesses certainly will include family members, but the highest-performing boards also will have independent directors, selected both for their relevant business expertise and for their sensitivity to and experience with family ownership (and high emotional intelligence). Individually and collectively, these independent directors can serve as guide, adviser and resource to your family on the full range of business issues.

The need for a high-functioning board is especially acute if the planning horizon includes rapid growth, generational evolution in family business oversight, or both. The right group to oversee a Gen 1 company (often the founder and his/her spouse) isn’t right for Gen 3, when 10-20+ siblings, first cousins and their spouses hold that baton. Nor is the right group to oversee a $50 million revenue company the same as the one that would effectively steward your company when it has grown to $500 million in revenues. Owning for the long term demands clear distinctions between “lifestyle” elements of a business and the gritty realities of sustaining competitive eminence, including coming to grips with the right – and wrong – executive or board roles, if any, for family members.

  • Exercise governance discipline. The simple habit of meeting regularly as a board – whether quarterly or more often – changes things for the better in companies. Add in specific oversight processes (normally via committees of the board) and risk is mitigated, opportunities can be exploited comprehensively and the business will get stronger. Constructed in partnership with the company’s executive leadership, these processes can include annual plans and budgets, rolling three- to five-year strategic plans and related capital planning, reviews of banking and debt arrangements, consideration of liquidity requirements, operational reviews, tracking of key performance indicators, talent planning and consideration of specific risks and opportunities. Effective governance clarifies and separates the roles of board and management, creating benefits for both.
  • Plan for growth. Private equity has a growth mindset. So should your business. How will your company sustain its reputational strength and its business and financial success? Boards must regularly ask: Is the business truly positioned to continue to thrive? Do we have the resources – capital, talent, processes, channel relationships – to thrive? If the answer is no, it’s time to rethink.
  •  Align talent with accountability and incentives. Aligning incentives is one of your company’s simplest and highest ROI levers. Enabling executive leaders to grow personal wealth in parallel with shareholder value growth is a powerful force in retaining talent and aligning all parties, especially when there is a mix of non-family and family leaders; the same is true for independent directors. If true equity is not possible, you can utilize highly effective quasi-equity alternatives.
  • Optimize the balance sheet. Solving for capital adequacy is decidedly different for family companies than for PE owners. What are the capital requirements to execute a growth plan while ensuring assets for estate planning and other family purposes? What other parts of your family enterprise have capital appetites? How should these considerations inform your core business’s capital plans? These questions are essential to long term sustainability, as generational evolution and shareholders’ demands for partial or even full liquidity are inevitable in families.

What is the optimal level of debt for your business, given business cyclicality, macro factors, capital spending requirements and board and owners’ risk tolerances? A business with a fortress balance sheet can pounce on opportunity when others are struggling. And a family owner with risk concentrated in one business will appropriately regard debt very differently than a PE manager with a diversified portfolio of companies in one or more funds.

  • Allocate capital with intention. Families who intend to hold their companies for the long run nevertheless benefit from a periodic business re-underwriting, as private equity overseers would: a re-assessment of opportunities and risks, leading to an explicit commitment to the business’s future, the roadmap and the resources required. Your family has a responsibility to itself to allocate its financial and human capital critically, against specific criteria for success and evaluations of risk. And just as private equity firms assess risk both within companies and across the fund, your family should assess risk across your full enterprise. Often, thoughtful dividend policies and other forms of periodic partial liquidity, as well as intentional management of assets (and liabilities) outside the core business, can go a long way toward mitigating risk and achieving diversification goals.
  • Invest in shareholder relations. PE firms invest heavily in communicating with and managing their investor base, and family-owned businesses should, too. What information should routinely be shared with shareholders? What other opportunities should be available for shareholders to learn about the company? How will the next generation of family leaders be educated, engaged and given constructive voice? What is the role of non-board shareholders? For sustainable long-term ownership, what shareholder “safety valves” might be useful? For example, should the shareholder agreement provide a transparent path for partial or even full liquidity for certain owners? Such “off ramps,” if planned well, can allow those with the calling to continue to own for the long term, while recognizing and accommodating others’ divergent priorities. This is especially pertinent when Gen 3 takes the reins: there simply is no way that 10 to 25+ siblings and first cousins (and their spouses) will all see things precisely the same way.

So Why Not Just Sell to PE?

PE funds necessarily have a short-term perspective. They manage for “consistent deployment” of the capital in their funds. They seek to invest funds over about three years, and to harvest those investments over the ensuing three to five years. For most, a five-year hold is long-term.

Second, as noted earlier, the leveraged balance sheets and large interest burdens typical of many PE-owned companies can result in negative outcomes for employees and communities, in addition to constraining long-term investments to grow, further competitive advantages or exploit down cycles.

Finally, the transition from being a business-owning family to a “financial family” is fraught with challenges, both financial and familial. On the financial front, have you considered what sale proceeds would be after-tax, especially as you likely have significant unrealized gains? What kind of return would you need to achieve on the after-tax proceeds of sale to match the annual compounding you are getting now from the business? What are the estate planning implications of selling the business? You are an expert on your business; what expertise do you have as an overseer of financial assets? Finally, on the cultural front, families often find it difficult to replace the ethos, rigor and identity endemic to business ownership. Extensive forward planning is essential to enabling your family to thrive in the absence of the business.

Play to your strengths – and remember, this is not all “financial.”

Your family has cultural assets as well as capabilities that PE funds do not possess. As a family-owned business, you can choose an unlimited investment time horizon. You can diversify your family enterprise without selling the business. You can govern without managing. You can separate ownership from control as you carefully shift the enterprise from one generation to the next. Equally important, you can own a business for reasons beyond financial returns. You can live the values of discipline, constructive engagement, stewardship, the presumption of good will and the tolerance to let family members live their own lives without undermining the core economic engine. You can remain stalwarts and invest generously in your communities, serve customers well and reward employees handsomely in ways that reflect everyone’s interests and your values.

Periodically re-underwriting a family business against your chosen criteria aligns your family enterprise with your values and priorities. We have found that such intentional assessments, coupled with consistent communication among shareholders, contribute materially not only to sustainable ownership of a thriving business and personal wealth but also to family harmony and shared vision and values, especially as the generations evolve.

Simple but not easy? Sure. But worth the investment if your family wants to sustain its company’s economic and business eminence, plan for generational change and thrive across generations.

Susan Lucas and Rod Goldstein are two of three partners of Wealth Strategist Partners, a Chicago- based adviser to complex families of significant financial and family business wealth. 


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