Like-Minded Partners

Demands for such transparency shouldn’t be considered unusual, as it’s the way individuals protect their investment, says Thomas D. Davidow, founder and principal of Thomas D. Davidow & Associates in Brookline, Mass. Davidow is a psychologist who specializes in family business consulting.

“The way the investor can protect himself is through due diligence and through the agreement itself,” he says. “Family dynamics can be unpredictable. The investor can ask for a seat on the board of directors and make it part of the agreement that the family cannot be paid until certain performance benchmarks are met.

“Extensive due diligence is needed on both a quantitative level and a qualitative level. The investor needs to find out about the family and its history,” Davidow says. “Continued communication between the investor and the family business owners is necessary.”

Women Key Players
Such investments are one avenue through which women have exerted more influence in the private equity sector, he notes.

“The number of women who are willing to invest in family businesses is rising because women are more relationship oriented, rather than task oriented, and that is what is needed in these situations,” Davidow says.

Individuals are also more inclined to invest in an industry that they’re familiar with, says Lorraine Fox, director of wealth management at Aspiriant, a multifamily office in California’s Silicon Valley. “The potential investors we deal with love technology and are risk tolerant,” she says. “They feel the risk is worth it and they like being part of the technology environment, so they like to invest in family-owned tech companies.”

Investors can either have equity in the company or debt; if they have debt, they get paid back first, she explains. “Those who invest or loan money usually do so in an industry where they have an interest and with people they trust. Also, the investors are not risking their entire portfolio; this is only part of the money they have to invest.”

Some high-net-worth individuals look at investments in family businesses as just another one of their asset classes, says Andrew Keyt of the Family Business Center at Loyola University in Chicago. “There are great opportunities in established family businesses, which are less risky than venture capital. Many families have great business models; they just do not have the capital to take on new strategies or expand to the next level.

“This is a trend that definitely will continue to grow,” Keyt adds. “Owners of family businesses are looking for sources of capital that have a longer term time horizon, and the investors are looking for a stable growth strategy for their investments. The investors usually have some sort of business experience and they believe in encouraging family businesses. So there is a real niche for those two to get aligned and marry up with each other.”

The Role Of Advisors
The financial advisor can play a crucial role in this partnership by seeing how it fits in with the investor’s entire portfolio. “You don’t want to put 80% of your portfolio into a family business,” says Keyt.

On the company side, the negotiations depend on how desperately the owner needs the money, says David Karp of Pagnato Karp, a wealth advisory firm in Reston, Va. “If the business owner absolutely needs the money, he or she may have to give up something, but if the money is discretionary, the business owner has more options to negotiate.

“There is always a concern about control from the business owner’s standpoint and that determines how the agreement is structured,” Karp says. “The owner may need money to grow in a new area or to penetrate a new geographical market. The fact that a company needs money does not mean it is broken or a bad investment.”

Business consultants and banks can be brought in to help find matches between companies and individual investors, according to the KPMG survey.

Individual investors should get to know the family and to seek out younger family businesses, the report says. “Our survey suggests the younger the business, the more likely it is to be open to offering equity,” KPMG says. “Therefore, first-, second- and third-generation companies are more likely to find the involvement of a [high-net-worth investor] more attractive than a sixth-generation company.”