Family-owned businesses make up a large share of the world’s current economy. No matter their size, these companies confront many of the same challenges as non-family-owned businesses—managing growth, hiring the right people and competing for market share. Given their ownership structure, however, family-owned businesses face distinct issues that can affect both family relationships and business strategy in complex ways. In this article, we examine how outside investors can help these dynamic companies successfully navigate those unique and interrelated challenges.
Liquidity and control
Almost by definition, a family-owned business is a highly illiquid asset. Although owners of family businesses may be worth millions of dollars on paper, they still worry about the mortgage, tuition for children and grandchildren, or personal guarantees made to banks on behalf of the business. While these owners would like to reap the fruits of their labor and achieve enough liquidity to secure their personal future, they do not want to starve the business of needed cash or sell it too soon. What are their options for achieving liquidity without giving up control of the company?
Those were some of the complex issues facing Sybari Software, a New York-based security software company managed by Cofounder, CEO and President Bob Wallace and his two sons-in-law. Bob had always resisted outside investment, preferring to reinvest cash flows to support steady growth. As he grew older, however, Bob began to think of ways to provide financial security for his family. In 2001, Summit Partners made a minority investment in Sybari, providing Bob and his sons-in-law with immediate partial liquidity. While leaving Bob firmly in charge of operations, Summit helped Sybari expand its board and management team. Over the next four years, Sybari grew 30% annually and became attractive to both public market investors and acquirers. As Sybari prepared for an IPO in 2005, Microsoft offered to buy the firm. The acquisition positioned Sybari for further growth and assured the financial security of Bob and his sons-in-law.
Expanding the team
Family business owners tend to rely on people close to them—spouses, children, long-time friends and employees, and trusted advisors. When the company is growing rapidly, however, entrepreneurs may require the expertise and perspective of outsiders. An experienced CFO, for example, can help a company navigate more complex accounting requirements, while an executive with international experience can work to establish a global presence. Even so, recruiting outside executives and integrating them into the family-owned business structure can be daunting. Business owners must assure new hires that their career paths are secure within a family-owned company, and they must help long-standing employees and family members understand the role of the new manager.
By bringing in additional expertise, an outside board can help the family-owned business make the transition toward a larger, more professionally managed company. This board should include representatives of the family as well as outside directors with experience relevant to the company. In 2007, the American Family Business Survey found that more than one-third of the businesses it served maintained an active board of directors and that more than half of those firms rated the board’s contribution as excellent.
On its path toward growth, AlphaSmart, a manufacturer of computing device keyboards for schools, expanded both its management team and board. Brothers Ketan and Manish Kothari and their partner Joe Barrus founded the California-based company and built a successful product for the educational market—a computer that was simple, affordable and durable enough for elementary and high school students. Yet, as their company grew, the founders knew that they would require more expertise. After investing $20 million in AlphaSmart, Summit Partners helped the founders hire seasoned veterans for the positions of CFO and director of operations. Summit also assisted AlphaSmart in building an independent board with the requisite experience and perspective to guide the company to success. Over the next five years, the firm grew from a single-product company into a provider of diverse technology solutions to the educational market. AlphaSmart went public in 2004; one year later, Renaissance Learning (NASDAQ: RLRN) acquired the company.
Succession planning and exit strategies
All founders must eventually choose a successor, but the decision is particularly fraught with emotional issues in family-owned firms. Should the future CEO be a family member, or should the family find the most qualified outside candidate? If the latter, how can the founders be sure that the new leader will run the business in a way that aligns with the family’s goals and values?
In many cases, succession means transferring ownership or management of the firm outside the family. Business owners who do not want to pass on their business—or who do not have an obvious successor in the family—might consider selling their business through either an IPO or a strategic acquisition.
Marc, Oliver and Alexander Samwer founded Jamba! in 2000. The three brothers knew that they would eventually want to sell their digital multimedia content company, just as they had sold their Internet auction company a few years earlier. Based in Germany, the company had a limited profile among U.S.-based financial firms and investors. By taking on Summit Partners as an outside investor, the Samwer brothers hoped to increase their visibility in the U.S. market, while expanding their business from Germany to the rest of Europe. In 2003, Summit invested in Jamba!, and by the next year was already working with investment banks and strategic buyers to prepare for an IPO or acquisition. Due to this dual-track process, in 2004 VeriSign (NASDAQ: VRSN) acquired Jamba! for $273 million—one of the largest technology transactions in Europe that year.
The role of an investor
Built on the sweat equity of their founders, family-owned businesses often grow for many years without outside capital. As these companies reach a certain size and their founders begin to consider retirement and succession, family-owned businesses can often benefit from a partnership with an outside investor.
Great care should be taken in selecting the right investor, however. Families that seek to maintain control should ensure that the chosen firm has a long-standing history of minority investments and a proven ability to add value without micromanaging day-to-day management decisions. Families that intend to cede control should look for investors that have been successful in bringing companies like theirs to the next level, while respecting and amplifying the values and priorities that first made the business a success.
Ideally, outside investors can provide capital and guidance on the critical issues that face companies as they grow to the next level—strategy, management and board recruiting, financing, acquisitions and networking with potential buyers. They can also offer an impartial perspective on the difficult emotional issues that family ownership can entail. Moreover, as minority investors, they can provide all this support while leaving day-to-day control in the hands of the family.