Davis and Tagiuri define family businesses as “organizations where two or more extended family members influence the directions of the business through the exercise of kinship ties, management roles or ownership rights."
In simple parlance, family businesses are those that are owned, managed and/or are significantly influenced by a family and the family have a final say in whoever is responsible for managing it. Family businesses constitute a very significant part of any economy across the world. Almost, 80 to 90 percent of all businesses are family owned. Worldwide 60 to 70 percent of GDP is derived from family businesses.
Traditionally, India has been a breeding ground for entrepreneurs. India’s transformation into a service-sector economy coupled with the advent of liberalization witnessed a surge in the aspiring entrepreneurs across the sectors and geographies. According to a World Bank report, India has 13 million SMEs in the manufacturing and services sector. In India, 90 percent of the employment generated in India is in small and medium enterprises which are by and large family businesses.
Family Run Biz Exhibit Higher Rates Of Growth
Many of the family run companies have a well established business models but tend to exhibit growth rates higher than the growth rate of large size companies. Hence, such companies are a great way to invest in businesses that are under going transformational change without taking the risk of venture investing where in majority cases viability of business model is yet to be established. There are significant value accretion opportunities through increased scale of an already well established business model.
Family run businesses in specific are a great platform for PE fund manager to add value and generate alpha return. PE fund manager can enable the evolution from relationship-based culture to professionalism. PE investor can add significantly to the institutionalization processes of mid-size companies through own knowledge and professional acumen. Investments by PE fund help enhance credibility of the investee company with all its stakeholders. Results in better traction and visibility with potential customers, financiers, regulatory authorities and is a great comfort factor for outside professionals.
As can be seen from the graphs above mid size companies tend to have a higher sales and profit CAGR relative to the large cap companies. However, there PEG ratio tends to be significantly lower than large cap companies. Mid-size companies, with highly scalable business, are a great way to achieve significant multiple expansion.
Emotional Connect - Investor Interest : Huge Mismatch
As discussed above, family run/owned enterprises offer very appealing investment opportunities. However, we think, based on our experience of investing and evaluating multiple such opportunities, that there are several challenges as well. One of the biggest challenge is the expectation mis-match. Family owned/run enterprises are typically very promoter centric. Hence, a promoter finds it challenging at times to accept PE fund manager as a partner in real terms. At the same time PE fund manager at times are not able to appreciate the sensitivity the promoter has on some of the critical issues.
Deal structure and valuation is another area where there could be lot of friction. Promoters have lot of emotional connect with the business and view their enterprises as highly valuable. At the same time they are very sensitive to some of the typical PE conditions such as drag along, affirmative consent, organization restructuring, etc.
We think that it is important for the PE fund manager in the beginning to give enough time to establish trust with the promoter. Once the trust and mutual respect is established then it is relatively easy to work through the changes that the PE fund manager wants to effectuate.
Promoters are gradually recognizing the value addition that the PE fund manager brings to the business. They are very open to suggestion on organization development, management information systems, fund raising advice, etc.
Family run/owned enterprises are a great investment opportunity. It is important to recognize the sensitivity and the emotional connect that the promoter, especially of a family owned business, has with his/her business. A PE fund manager can gradually establish the trust and gain respect of the promoter. A partnership approach between the promoter and the PE fund manager could go a long way in value creation for all the stakeholders.
(Rakesh Sony is the director of Motilal Oswal Private Equity. Vishal Gupta is the Vice President of Motilal Oswal Private Equity).