Why Family-Business Entrepreneurs Should Embrace Private Equity Funding

Trump's tax plan means it's wise to get better-acquainted with how to identify the right private equity investors and maximize relationships with them.

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By Jeff Johnson • Jan 1, 2018 Originally published Jan 1, 2018

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With the passage of President Donald Trump's tax plan, family-business entrepreneurs seem to be getting a big bump in social investment and corporate growth. Given that 80 to 90 percent of U.S. businesses are family-owned and that such companies contribute 64 percent of the GDP, according to Kennesaw State University research, the administration has taken a hardline stance in highlighting those businesses' economic and cultural value.

Yet this tax overhaul isn't without its problems. Especially when it comes to the private-equity space, the plans to limit deductions on debt interest can actually hurt family-business entrepreneurs who rely on this forward-focused capital in order to innovate and expand. With both possibility and uncertainty on the horizon, family-business entrepreneurs need to better understand the resources that private-equity firms offer as they prepare to forge ahead.

Related: A Beginner's Guide to Private Equity

The myth of the malicious PE firm.

Historically, many firms in the private equity industry suffered from negative reputations, which were based on companies that "stripped and flipped" investments. Those firms' emphases on short-term returns -- and disregard for stakeholders -- gave many in the field a bad rap and led to some misconceptions that are contrary to what most PE investors actually accomplish for entrepreneurs and family businesses.

Still, some industry insiders believe that PE firms don't support existing management teams or cultures at the companies in which they invest, while others are skeptical of PE investors because they have reputations for overleveraging companies. While PE firms are largely constrained by strict regulations from both the government and lenders, these fears are relevant. The New York Times ran a story about a now-defunct Atlanta-based family business that partnered with a firm that had no knowledge of its industry -- one that also fired the individual whom the founders had signed on to work with in the first place.

Given that PE firms are interested in making money for their investors, it's easy to assume they would care about and understand their portfolio companies. For most PE firms, that is the case. But family businesses wanting to delve into the PE space shouldn't rush in without first knowing what PE firms have to offer and why that matters.

Why family-business entrepreneurs should lean on PE.

Private equity investments can serve as catalysts for growth and product development for family-business entrepreneurs by helping bring precision and accountability to those companies. Family-business entrepreneurs often fail to govern themselves well, and their output suffers as a result.

On the other hand, PE firms understand the importance of good governance and can help such companies implement strategies such as a value-added and independent board of directors, audit and compensation committees or even conduct third-party reviews of existing strategies. As a result, the company's leadership will be better equipped to identify risks and make smart, goal-oriented decisions within their marketplace.

Moreover, family businesses can benefit from PE firms' expertise in the areas of strategic planning, financial management and controls and shoring up companies for sustained success. Most PE firms maintain relatively small portfolios, so they can invest significant resources into engaging their companies and working with them on value creation and long-term planning. By instituting top-to-bottom incentive programs, private equity firms can drive increased productivity throughout the organization.

My firm, for example, distributes outsized performance bonuses to family-business leaders and other executives who exceed our expectations, as we know this will inspire them to keep innovating and achieving.

Certainly, not every PE opportunity is a good opportunity. Family-business entrepreneurs who are considering taking private equity funding can use the following steps to identify the right investors and maximize those relationships:

Related: The Do's and Don'ts of Private Equity for Entrepreneurs

1. Do a little bit of soul-searching to clarify needs and goals.

Finding a PE partner begins with organizational soul-searching. As your company's founder and leader, do you want to exit the business or stay involved? How much money do you need to fulfill the business's goals? What value do you offer a PE investor? Answering these questions -- and knowing what you hope to gain from the relationship -- will help you target firms whose expertise aligns with your outcomes.

According to a study by McKinsey that tracked 200 family-owned companies over a 10-year period, those companies relying on passive portfolios performed less well than those relying on active portfolios to stimulate evolution and innovation. But if you're considering a firm that doesn't align with your growth strategies, then it won't matter how successful your pitch, because you won't be speaking to the heart of investors' interests. They, like you, want to match goals by understanding how your company serves as a unique asset in their portfolios.

2. Make use of the business (or online) community so that you won't be left stranded.

Know what you're getting into so that you don't enter a deal unsuitable or unsustainable for your company and its goals. You can meet with executives who run companies similar to yours and who've taken PE investments, or you can do your own research on signing on with a PE firm.

When Reungdej Dusdeesurapoj and his family decided to align their family-based insurance company SMK with a PE firm, for instance, they navigated challenging negotiations on company control. This process, which ultimately took four months, is a good lesson for many entrepreneurs who may be anxious to dive in without first understanding the nuances of an agreement.

Regardless how you approach this research, you'll want to get the full view of what it will be like to work with a specific PE firm before you make such a decision for your business. If you're struggling to identify potential investors, local small business development organizations or your area's chamber of commerce should be able to help connect you to relevant firms.

Related: What to Expect When Selling Your Business to a Private Equity Group

3. Measure the effort they put into the first impression.

You're likely not the first family business in your industry to accept PE funding. Verse yourself in other notable deals to be able to discuss what worked and what you think could've been handled more effectively. My team and I appreciate meeting with entrepreneurs who can offer constructive criticism on other deals. This shows initiative and an understanding of what a partnership requires to succeed.

A good rule of thumb when choosing a PE firm is taking note of how much effort they put into getting to know you and making sure you understand the terms of the deal. My firm holds several meetings with our partners before we get anywhere near signing a contract, and we'll often provide them with educational content to ensure that they're clear on what's involved. While some entrepreneurs find this process cumbersome, it's critical that both parties are on the same page.

Taking private equity can provide a great boon to your family business, but it is a major decision. The better you know your company's strengths, weaknesses and goals, the more likely you are to find a partner that will help you achieve your vision.

Jeff Johnson
Jeff Johnson is a managing director at Blackford Capital, with more than 23 years of experience in investment banking and private equity. Prior to joining Blackford, he served as a managing director and founding principal of Gilbert Global Equity Partners, a private equity firm in New York City.

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