Family business financing: Prudence is key amid recovery

David Craik reports on the options currently open to families looking to raise finance for their companies.

Business-owning families looking to secure finance or refinance their existing arrangements have found it particularly tricky of late as the repercussions of the financial crisis reverberate around the world's economies. Despite long-standing relationships with families, banks have been reluctant to provide loans on reasonable terms, while the public markets have been at historic lows.

However, some family businesses have been able to secure respectable deals and with the wheels of the financial markets beginning to turn more freely, prospects are starting to look much better.

In March, diamond producer De Beers Group, 40% owned by South Africa's Oppenheimer family, announced it had successfully concluded the refinancing of its existing banking facilities. The refinancing comprised a renewal and extension of the company's worldwide existing facilities and a $1 billion rights issue.

"The equity investment and the successful completion of the refinancing process is a clear vote of confidence by the lenders and all three shareholders in the management of De Beers and in the company's strong potential for significant growth," commented Nicky Oppenheimer, third-generation chairman of De Beers and managing shareholder.

The Glazer family, US owners of English Premier League side Manchester United FC, had been struggling to arrange a refinancing package to service their controversial £790 million leveraged takeover that they completed in 2005. However, in January this year the family launched a successful £500 million bond issue to replace its banking facilities and to repay loans.

Last December, family-owned UK regional media group Archant refinanced its existing debt facility of £50 million until April 2013. The company said the deal would help it secure its operating cash flow needs and leave funds available for strategic investments. Despite not revealing the details of the arrangement with the Royal Bank of Scotland and Bank of Ireland, group finance director Brian McCarthy said: "2009 was the most challenging year for raising new debt for many years. The media sector in particular has been under great pressure as a result of the recession and the banking world has also changed. We have concluded a great deal."

German family-owned trading and services group Franz Haniel issued its first ever bond in October 2009. The five-year high-yield bond was worth €1 billion. Non-family chief financial officer Professor Klaus Trutzschler explained: "The bond helps us to support our long-term financing as well as diversify our balance sheet on the liabilities side."

The company added it hopes to finance half of its €2.6 billion of net debt through the bond market using loans from about 40 banks for the remainder. So what lessons can other family businesses learn from these examples? It is clear businesses are finding funding and refinancing, but what options are out there? What are the advantages and disadvantages of each option, and given the more optimistic economic climate, note the mentions of "opportunities" and "future" in the above examples, is this a good time to make a move?

Bank on the banks?

Bank loans are the traditional method of funding for business, but they have been battered in the downturn as a result of both the buy and sell side caution.

Figures and surveys show a decrease in the amounts of money lent by banks in major countries from the UK to the US and Australia. Businesses have complained of banks imposing tighter terms and conditions such as personal guarantees and more expensive transaction costs.

However Alex White, partner at accountants BDO Stoy Hayward, said bank lending is still a major option for businesses looking at debt finance or acquisition finance. "There has been quite a significant thawing in bank's attitudes to loans since the late summer of last year," he said. "It is possible for businesses to access debt.  Banks are open for business. It is improving, it is getting better."

However the hangover of the credit crunch looms large.White said businesses should expect the amount of money lent to them by the banks this year to be "clearly lower "than they would have received back in 2006. "Banks will generally be reluctant to lend more than about three or four times EBITDA to medium or larger sized profitable cash generative businesses. Fees are also much higher than they were," he said. 

"Money is available but getting more than £25-30 million of new money in a deal or an arrangement from an individual bank will be challenging. They don't want to write new business of that amount. You will have to club around a few other banks if you want to get more. That would introduce other issues in that the success of the fundraising is only as strong as the weakest bank in that club."

So what advice does Wilson have for family businesses seeking bank finance? "Banks will scrutinise new customers quite closely. If a business is going in to raise significant levels of debt the key is to be really prepared for the process. Businesses should have an eye on understanding the people at the bank they are dealing with and know what they need to report up to their credit committees to get the debt approved," he stated.

Private equity open for business

Chilton Taylor, head of capital markets at accountants Baker Tilly, believes the continued "tough" nature of bank lending will lead family businesses on a "push to seek equity funding" in 2010.

"Banks are lending less and more expensively with a focus on lending to larger corporates. The maximum EBITDA of three is now considered racy compared with five or six in the peak three years ago," he said.

So does this mean private equity deals? "Private equity houses are beginning to fund total equity situations but they will need to seek exits or enhanced valuations in order for them to raise new funds," Taylor said. "Some are shut for business focussing on their existing portfolios. But others may see this as a good time to invest because valuations are realistic and trading is possibly more predictable than last year."

BDO's Wilson said the private equity market is "very open for business". He explained: "2009 was a year where little capital was put to work. But the private equity model breaks down if private equity firms don't put capital to work, so there is a real desire for managers to invest this year."

However, that desire is not being reciprocated by businesses. "There is a lot of supply but not much demand so if you do go for equity finance this is a good time as you could get slightly better deals than you were expecting," Wilson stated. "There is more money than deals."

Michael Quinn, associate director of corporate finance at accountants RSM Tenon said his clients are finding private equity a good option particularly if they are considering succession planning. "It can allow businesses to improve their balance sheet and credit rating. The disadvantage is that you give away equity and possible control of your business," he said. "Many private equity companies are also wary of businesses setting out their requirements as development capital when it fact it is more like rescue funding."

In March private equity giant 3i raised its own $1.2 billion fund to accelerate its growth capital investment over the coming years. It says it has seen increased activity in the large family business sector in 2010.

Justin Maltz, director, stated: "Even in today's downturn we're meeting many ambitious family business owners who recognise the need to accelerate their growth often through internationalisation to move to the next level. What resonates well is a minority equity partnership which allows them to retain control of their business but provides capital and active support, introductions and advice to support their growth plans."

Maltz said that given reduced availability of debt, which is likely to restrict buyout activity, the taking of minority stakes will be even more common this year.

"We believe there are strong opportunities for us to partner with ambitious and growing family businesses. We're speaking to businesses about possible acquisitions of struggling competitors in their sector, to rebalance debt/equity or repay debt within their business, to enable shareholder release or to allow the founders to diversify their own risk in the company," he explained.

Quality rules in public markets

IPOs, which have been as badly hit as the private equity sector, are another funding option. According to Chilton Taylor, the emphasis is now on quality: "Companies not only have to be suitable for IPO but also be prepared. That means strengthening management teams if necessary or developing robust financial systems. As this grooming process takes anything from a few months to possibly two years now is an excellent time to plan for this and seek early advice."

However, Wilson cautioned that there will be "quite a queue" of companies seeking IPOs. "The pricing for IPOs will be quite poor for a while because capital markets will have a choice and be able to pick and choose which ones to invest in. Investors will demand quite a good deal," he said.

Families open arms to other families

Another funding option for family businesses is somewhat closer to home. Harald Schedl, partner at strategy and marketing consultants Simon-Kucher, said securing finance from other family businesses is a viable option with the advantages of "trust and family ties".

He explained: "This can either be a loan or an equity stake. Mostly it is a loan as family businesses are normally eager to control 100% of the equity. However, if it is a separate business unit in a different country then an equity stake is more likely."

Schedl said businesses interested in taking this route, either to seek or provide capital, should talk to families they know or use a consultant or auditor they know well who is active in the family business sector.

Schedl is presently working on a deal involving an Austrian family machinery business which has secured financing from another family business. "The direction in this deal is towards equity as two of the owners were wanting to sell their stake," he said.

It is vital that family businesses investigate each other thoroughly; not just for the intricacies involved in each option but on how this new capital could affect their current structure and strength.

The addition of outside capital and stakeholders raises important issues such as how much influence newcomers could and will have on decision-making and how much your family is prepared to give up control of your business.

It is important to realise that outside capital does not have to mean losing total control of your business and giving up on decades of family ownership and history. It is possible to find ways and means where you can share control with your new investors and ensure hearty progress.

This can be achieved through devising an ownership strategy, such as defining your values, which can help you outline your pre-conditions for attracting capital and ensure you select the right financial option.

Whichever option your family business is considering and for whatever reason – restructure and pay down debt with today's lower interest rates, invest in modernising current assets, acquisition funding to take advantage of the recovery and the victims of the recession – you can be confident of gaining funding.

But it is a cautious confidence and you must be prepared for the much different and much tougher financing landscape that is post-recession 2010.

Prudence is a word from before the recession but John Ward, principal of the US-based Family Business Consulting Group in Chicago, also sees its use in 2010. "Look to grow your business with internal funds. Of course take advantage of special buy out or acquisition opportunities but be very, very prudent. Be careful with debt. These times don't change that kind of thinking too much," he said.

As usual, it appears the family business sector is not standing still when it comes to finding funding amid the world economy's nascent recovery.