In the first of an occasional series, Melanie Stern pilots a discussion with business families to examine how they view the private equity world. She finds perceptions are changing and the benefits are flagged up – but doubts linger about its role in business
Gustavo Adolfo Carvajal Sinisterra is chairman of the board at BICO International, part of Columbian media printing and supplies company Carjaval Group. Part of the fourth generation to run the 100% family-controlled company, Gustavo is also president of the Carvajal family council and on the board of the family foundation.
Eugene O'Malley is managing director of US family business strategy consultancy Cobblestone Advisors. Eugene has worked on cross-border transactions and expansion capital deals with family businesses for 25 years.
Elena Zambon is chairman of Italian pharmaceutical company Zambon Group which celebrates its 100th year in 2006, and president of the family office, Secofind. In 2001 Zambon Group founded Z-Cube, an industrial incubator company that provides capital to developing pharmaceutical projects,
Richard Weber is the managing director of a Hamburg, Germany-based family office, Weber Grundstrueckverwaltung KG, which is focused on managing a commercial and residential real estate portfolio. Richard is the third generation of his family to manage the business.
Once a dirty word, private equity now has an undeniable hold in the family business world and, like it or not, has proven itself to be of much importance. Families who haven't heeded the mantra warnings about the impact lack of management and planning in areas like succession planning, growth finance, risk, and professionalisation have all too often found that, having worked themselves into a corner, private equity houses are the only players who can help. Equally though, families who have deftly planned and managed their companies to success and decide to sell out for, say, a long and lazy retirement, have found private equity a welcome exit solution. The relationship is developing – but is the hostility to private equity from family businesses really thawing out?
Families In Business (FIB): Gustavo and Richard, any involvement with the private equity world at present?
Richard Weber (RW): We remain family owned.
Gustavo Adolfo Carvajal Sinisterra (GC): Our holding company is 100% family owned, but we have different businesses that are part owned by our partners – though they are not from the private equity world.
Elena Zambon (EZ): Our company remains family-owned.
FIB: Do you expect to experience a 'liquidity event' such as succession in the next five to 10 years?
RW: Ours happened five years ago and my son is only three right now. It might be a problem in 20 years.
GC: Our family is quite large; we are a cousins' consortium. The largest shareholder is our foundation, which has held 35% since 1961. The other 65% is spread across 160 family members. There are about five members of the first generation around, all about 70 years old; when they die, no one in fourth generation will personally have more than 2% of the company.
FIB: Might you need private equity then?
GC: We have recently realised that for some of our businesses to grow, we will probably need some private equity for the long-term plans, and some of our companies may go public. We would like to keep the holding company private though. We will have to learn how to work with these types of partners and it is a slow process, but fortunately there's no rush. We would like to expand in Europe but we want to be stronger in Latin America before that. We opened an office in China about eight months ago. We are teaming up with the International Finance Corporation (IFC) for our expansion plans.
FIB: A lot of families are against the idea of private equity, but not so against the idea of floating their company on the public markets. Is the idea of sharing control with a private equity house something you and your family feel comfortable with?
GC: So far, yes.
FIB: Eugene, what is your experience?
Eugene O'Malley (EM): The families face a few challenges: liquidity issues especially in the US arises with multiple succession, and a lot of liquidity events are driven by divorce and retirement. There are so many different sources of financing in the private equity arena that allow families lots of options. The market is broken down into many elements – from hedge funds to distressed debt; most families are going to look at a long-term investor such as a pension fund, and these types of investors are more conducive to working with families because their intention is not just to buy and sell to get an immediate return; they have obligations in the future that are matched with the outlook of a family business. Someone like the IFC is a good choice, they are well established and their interest rates are low.
FIB: Richard, from a German point of view – considering the Mittelstand market – is the private equity world of interest if you need it in the future?
RW: It depends. For our business of real estate we would have to seek a trade off; when we find a property we will buy half and find a partner to finance the other half. That partner could be a bank that lends fixed interest rates for between five to 10 years, and right now a 10-year interest rate is 4.75%. An alternative is private equity company would not be happy with a 4.75% yield, so therefore it is easier for me to use a bank loan. Also I have already established a close relationship with my bank. Ten years ago they were 8% so if a private equity company came along then with their expectations of 7% yield, it would be a different story.
EM: Another element to consider is that private equity companies will apply different criteria and yield to different types of businesses, so it would be different for a real estate company. There are specialised funds for that.
FIB: Gustavo, what is there in terms of private equity for family companies in your part of the world?
GC: It is not very big, but it is developing and many families take great interest in it. The public markets are not that prominent as they are in the US for instance, so it is about the options open to family companies. Also the stock markets seem to fluctuate in ways we don't really always understand, therefore the idea of private equity is preferable.
FIB: How many large families in this part of the world?
GC: There are many – at least 60-70% of our companies are family owned and are in multi-generations. They all deal with the issues Eugene mentioned – liquidity, succession and so on – and tax law is an issue for us. We're not that different from the US.
EM: I think these businesses are always looking to grow and there are really only a few places you can get capital where the interest rates are acceptable to the risk you will be taking when expanding the company.
In the US there are so many options from derivatives and interest rate swaps; for instance in Gustavo's part of the world, interest rates have gone from 5% to 18% and it is impossible to build your business against that environment, unless you have secure and stable capital. It's about measuring your company against the markets – the interest rates, growth, inflation, the impact the family makes on growing the business. Very few businesses that I've ever seen have been able to grow purely from internal cash reserves.
GC: It's totally true. Most business families have a long-term view and building slowly, to keep the company within the family's control. Those restrictions are sometimes hard to explain to outsiders with regard to capital.
RW: They say the first generation makes the money, the second generation keeps the money, and the third generation loses it…the last generation often has no emotional tie to the foundation of the business the way the founder did, they just see the money that comes from it.
EZ: It's a heavy responsibility. Last January we had a request from one of our brothers to exit the group and run his own company, and so we thought about private equity to facilitate it. But fortunately we had the capital to do it ourselves. We found a private equity house that was professional in its conduct, but when they say they are trying to help, they always have a clear financial objective behind them, which is not always the same view the family has – not just because the two have different philosophies, but also because the private equity house has to answer to shareholders and consider the figures first and foremost, aiming to exit in three years with an IPO.
EM: I think you are absolutely right that each of these private equity firms will have its own objective. The challenge the family has is finding the right partner who will understand their needs, which is hard because there are so many providers with so much capital and so many different structures. Families are not experienced in having to make these kinds of assessments. Recently I helped a family structure an interest-rate swap but the family wasn't familiar with the process. For many families, the only exposure they have to the private equity markets is the relationship they have with their bank.
FIB: Elena, you run a small private equity outfit yourself?
EZ: Yes. Z-Cube is an industrial incubator that started in 2001. It answered the problem that for SME-sized pharmaceutical companies, the cost of research was high; we have strong relationships with universities all over the world and we wanted to maintain a good deal flow; also we recognised that often when we were spending money on a project, the exact same research was being done in one of the universities already. We now have four projects that we have turned into companies and we are meeting with investors to ask them to participate. But we do not invest in start-ups, because this is far too expensive for a company our size.
GC: I'm curious about the new companies you say you are developing; will you own stock in these new companies?
EZ: Yes, about 30% depending on how high the research principal wants the level of investment from us to be. But the equities we provide are not just capital, we allow use of our own labs, and contact with our own experts.
EM: Industrial incubators that are family-backed are usually quite successful, but independent ones are not because they don't have the resources family companies do.
EZ: In Italy things seem to be done by trends; when one person invests in a hedge funds, everybody wants hedge funds. In the mid 1990s everyone was talking about private equity, but everybody was disillusioned by the reality of it.
EM: There is so much capital in the market because of the pension fund contributions, driven by the lack of returns from the stock market. That is why you end up with hedge funds. Traditionally mutual funds are not shorts, they are looking for long-haul investments so for pension funds who are flush with cash, they have huge obligations and are now structuring themselves in order to meet those obligations. The problem is that the success of middle-companies is really from hard work over a long time, and this is not a buy and sell environment. So the private equity companies cannot easily get the returns they have already promised their investors.
The German market is a good example; everybody believes there are thousands of Mittelstand family businesses out there that will soon come up for sale; the reality of these companies is that the owning families will wait until the 11th hour, 59th minute and 59th second before they decide to sell their company cheap. Each one will remind you that they have taken their company through wars, incredible economic cycles…then it is hard for a private equity company to come in and say, 'I will buy your business and turn it around for X' because they will just ask you why they did all this work only to sell it to you.
EZ: It is important that you trust the people who you consider doing this sort of deal with. I would choose a private equity company because if it is representative I have a good rapport with him, and I could accept him as a member of our board of directors. In Italy specifically, all the big banks from the US came in and sent relationship managers who had no idea how to manage companies; but these guys are supposed to explain to me how to do better in my business. It's the same case in the consultancy industry, they send the junior and you waste a year explaining to them how to run a company. So sometimes I prefer to pick an Italian team only because I will be better able to assess his competencies. There was one case of a family business in Italy who wanted to join the markets. He made some acquisitions and a private equity house approached the company. He decided to abandon his plan to float the company and hire the private equity house because he believed they knew the financial markets a lot better than he did, and thought they would provide advisory support on choosing the right investment bankers, and on major decisions.
Two major private equity houses approached us a few years ago; they were professional and had transparent rules, but in our case they came to us without understanding the family shareholding or involvement, and just put an offer on the table for the majority of the family holding and expressing their view on the value of that holding, offering a non-binding offer which means nothing – it is just a piece of paper. We decided not go with it.
EM: If you wanted to grow your company in new markets but you didn't want to put the family's holding at risk, or take out loans to do it, then private equity becomes a valuable tool. For instance, the private equity company could own 40% of your business portfolio in Beijing. You're not selling your core business that way, because we know most families are risk-averse. Families can also use private equity to acquire other businesses and grow the business to a point where they can sell it.
RW: It is the private equity industry's responsibility to convince family businesses about their intentions.