How family businesses can use external funding to their advantage
Duncan James, head of family business at law firm Shakespeare Martineau and sponsor of the Service Excellence Award, explains what options are available for family businesses who are looking to grow.
Many longstanding family businesses have staved off economic turbulence with savvy decision making and good cash management but when it comes to cash reserves, should it remain in the bank? With a keen eye on wealth planning, external support and funding options, family business owners could protect the fortunes of their business while realising valuable investment opportunities.
Business owners often view surplus cash as ‘risk capital’ that should be kept on standby if the market crashes again. Although the economy is experiencing some volatility, family businesses could be holding on to their cash for too long and should consider leveraging its value to make important business developments.
Before business owners consider using their cash reserves for investment, understanding the fundamentals of wealth planning must be thought through first.
Clear objectives are vital
For many owners, not identifying what their wealth preservation strategy is can be common. What the function and goal of the family business is, should be the first question and will help to set clear objectives and understand the main reasons for running the business. For example, not every business is run to make maximum profits, some are for lifestyle, cash extraction or legacy motives instead. Once the business goal is established, owners can identify what level of risk can be taken, what investments should be made, and if appropriate, whether external support could be utilised.
Cash flow management is crucial and using some cash reserves to better the business in certain areas doesn’t mean draining the bank account completely. However, some capital could be used to develop a few key areas of the business. According to the Federation for Family Businesses, 60 per cent of family SMEs plan to invest in the skills of their workforce to support business growth for the next year.
Although investment in staffing skills is vital, there are other areas to be considered, some of which could benefit from external experts or funding options. Some businesses may want to develop one area of the company, for example an e-commerce facility or advancements in factory technology and in doing so can ringfence these investments, while protecting the wider fortunes of the business in the process. Alternatively, external funding can be used alongside existing cash reserves to help segregate parts of the business or assets from the more risky trading parts, or in fact, to provide safeguards for the wider family against a change in fortune of the main trading entity.
Using external experts is often a practical, logical and common sense move to inject much-needed relevant technology, sector or management expertise which may be lacking within the current workforce. Family businesses should not be scared to take external advice.
Understandably, owners can be reluctant to let outsiders into the fold of the family business but to overcome concerns around losing financial control, share options can be put in place to ringfence finances or separate out the value of the business into capital ‘before’ and ‘after’ a new member joins the business. As a result, the new addition will take their share from the new wealth that they create, rather than what already exists.
Family business challenges
There are many forms of external funding arrangements that can support business growth too. Borrowing from traditional financial lenders, such as banks, is the most common method but agreements can be subject to economic changes, for example, the impacts of Brexit or industry-specific turbulence. It is crucial for business owners to regularly review the terms of their arrangements to ascertain whether funding is likely to be pulled under certain circumstances, if the arrangements are still favourable during long contractual periods and also how the funding will impact future successors.
Securing investment from venture capitalists (VCs) is another option and this is no bad thing for family businesses that are looking for rapid growth and a helpful capital injection. However, this is not for everyone and certainly not appropriate when the family is pursuing a legacy approach whereby passing the value through the generations is the main objective.
Most VCs are looking for maximum benefit from short-term lending and usually adopt a more aggressive approach to business decision making.
As well as other more unconventional forms of funding, such as crowdfunding or invoice factoring, using the expertise of High Net Worth Individuals (HNWI) is quickly becoming a popular funding option. For businesses looking to broaden their business network and connections, securing investment from a single person with specialist expertise in the same field can be invaluable. Not only can such an individual play an important role in financing key investment opportunities, they can also improve business connections and provide ongoing mentoring. In doing so, contracts can be drawn up to protect a percentage of the family wealth while not hampering future business growth.
Although holding on to capital can improve business stability and protect from economic shocks, a family business owner’s desire to keep control of equity can limit growth and delay future planning in some cases. Establishing an appropriate cash cushion, while seeking out investment opportunities and the means to get there, will help family businesses maintain control while reaping the rewards of valuable investments.
Duncan James is the head of family business at law firm, Shakespeare Martineau.