Start your search for capital from the inside out. There are no limits on the use of savings found within your business.
FAMILY BUSINESS MAGAZINE – Summer 2006
– "Cash is King." That’s what my father told me in 1997 when I entered
our family business, a company specializing in remanufactured starters
and alternators. Over the ensuing years, I learned firsthand about how
a family can struggle in attempting to allocate capital to meet both
the needs of the family members and the needs of the company. In
today’s business world, where resources are constrained, running a
family business that supports both the family and the business can
involve some tough decisions.
Fortunately, you can avoid such situations if you have sources of
capital available to you other than just the cash on your balance
sheet. And there are many avenues to achieve this without stealing from
the future of your company. Here is a step-by-step guide to raising
these “hidden” sources of capital for your family business.
Writing a business plan
Create a three-year business plan that provides a detailed outline
of what your business can achieve while framing the amount of capital
needed to achieve your goal. This step, if done correctly, is both
time-consuming and challenging. But if you give it an appropriate
amount of attention, your plan will help you understand what you want
from your business.
Do you expect explosive growth, or do you want to stay the course?
Are you cashing out a shareholder, or are the shareholders in for the
longer term? Consider these big questions: What would you do
if you had all the capital you wanted to invest? How much would that
be? What would your company look like then? What would an aggressive
plan look like? When you finish this exercise, you will be armed with
an understanding of what your business can become, what you want your
business to become, and how much and what type of financing you
require.
Starting from within
The best part about running a family business is that it is your
business. Any savings found within your business accrue to your
benefit, with no limitations on how they are used. Therefore, this
unrestricted source of capital is the perfect starting point for your
search. There are many levers within your business today that can
increase the cash you take home at the end of the day. Here are three:
1. Your balance sheet. Can you collect your
accounts receivable faster? Are you offering discounts for early
payments? Can you stretch your accounts payable in exchange for more
business? Have you shopped around for new suppliers, or have you stayed
with the same relationships for years? Running a reverse auction with
your suppliers might generate additional unexpected savings. How long
does your inventory sit on your shelves? Can you work in smaller batch
sizes to decrease the amount of capital you have invested in your
inventory at any given time?
2. Your operations. There are many excellent
process improvement consultants who will work on a contingency basis. A
fresh set of eyes may help fix existing issues and may cost you little
or no additional money. This process may also free up resources within
your company, enabling you to achieve your aggressive growth plans.
3. Your customers. Do you have customers who always
seem to adjust their orders or take up too much of your employees’
time? Analyze the gross margins on serving those customers; are they
worth the gross profit you are receiving from them? Is there a way to
add additional value to your offerings to increase prices? Can you
decrease prices for your hassle-free customers to encourage them to
order more, thus offsetting the cost of “firing” problem clients?
Looking outside for help
Outside investors have been funding other people’s businesses for
centuries. Each form of outside investment comes with different types
of restraints. Depending on your business goals, some sources of
capital may be a better fit than others.
1. The Bank. Most family businesses have bankers
they have worked with for many years. Revisit your bank lines. Can they
be increased because your business has grown? Interest rates are still
relatively low and provide tax-deductible interest expenses that might
offer an economical way to increase the value of your business. While
traditional bank debt does not dilute your ownership, it is generally
limited to a percentage of your assets, requires a first-lien security
interest on those assets and involves strict reporting requirements on
a weekly basis. Some banks may also require personal guarantees on your
loan, forcing you to put both your business and personal assets at
risk.
2. Mezzanine Lending. Perhaps you want a more
flexible lender. Many lenders are willing to provide mezzanine capital,
which involves fewer reporting and security requirements than a
traditional bank. This form of debt also does not reduce your
ownership, but mezzanine lenders tend to provide less money than banks,
and their interest rates are higher. This is rarely a long-term
solution for a growing company because of restraints these lenders
impose on your business. They often limit the amount of capital you
can borrow and place restrictions on the amount of cash you can
reinvest in and take out of your business.
3. Friends and Family. What about your friends and
family? You have run a successful business for years; perhaps those
close to you would like to invest in its continued success. This can be
done in the form of a debt or ownership. Again, this money usually
comes with fewer restrictions than bank funding but is not often a
long-term solution. Capital-constrained businesses looking to grow
usually need deeper pockets than can be provided by those in their
inner circles. Additionally, it’s important to weigh potential help
from this arena against the possibility that any family tensions would
be exacerbated.
4. Private Equity. If you need significant
capital to grow your business or cash out family members, an outside
equity investor might be your best option. Many private equity firms
are set up to invest in quality family businesses and help them grow to
the next level. They offer your family the ability to monetize some of
their investment while retaining a portion of it in the company.
While they do not require a security interest on your assets, most
private equity firms want to help direct the future of the company.
This does not mean running the company on a day-to-day basis. Instead,
the private equity firm provides oversight and industry expertise via a
board position. Most private equity firms look for a specific time
frame for liquidating their investment. Unless you can afford to buy
the private equity investor out, this means a predetermined date for a
sale. That being said, a few private equity firms have an investing
philosophy that does not impose this constraint.
If you go this route, it’s important to choose your investor wisely.
Find an outside investor with both the assets and the point of view
that fit in with your company’s vision of the future. Do they have the
capital to invest and grow your business? Do they bring more than just
capital to the table (i.e., can they help you grow to the next level)?
Do they understand your business and have the expertise needed to grow
it? Do they have the flexibility you need to fulfill your plan? Can
they understand your family dynamics and company culture, and work well
with your operating team? Are your time frames similar? Be sure to
answer these questions when determining how to raise outside capital
and selecting a partner.
To make the most of an opportunity for outside capital investment in
your family business, begin with a well-crafted business plan and make
sure you are using internal levers to strengthen your cash position.
This will put your company in the best possible position when you
approach an outside capital source.
Eric Cohen is a managing partner at WHI Capital Partners, a family-based private equity firm located in Chicago (www.whicapital.com).