‘Do not borrow money’ has long been the mantra of family businesses. In fact, it originates back to the Great Depression and the failure of many small businesses as a result of being forced into foreclosure or bankruptcy.
The once tight-knit relationship between a successful entrepreneur and their local bank manager was pulled into question for the first time. The reputation of traditional, high street banks plummeted and those family businesses who either survived the Depression or were started afterwards, had an unusually risk-averse outlook.
Business owners became extremely protective of their livelihood, almost obsessive about the security of their assets. Any growth was going to be driven internally, financed from profit-generated cashflow, and not borrowed from the bank.
This paranoid approach to protecting every part of a growing business became intrinsic of family enterprises, like a newly acquired DNA to be passed to future generations. If they were going to survive, they were going to do it on merit (sweat equity!) and not on external finance.
And so, the glass ceiling for many small businesses was created (and remains). But the reluctance to borrow restricts the true potential of their business.
Fast forward 80 years and the availability of a wider range of finance options could be having an impact. The outlook is shifting and the move away from bank dependency is helping to change the funding landscape for many family businesses.
Although the first port of call will always be family member investment, there is the likelihood that this could run dry. Up next is the traditional bank loan.
Undoubtedly the most long-standing and reliable method of externally financing a family business, banks loans can also be the most difficult to secure. Banks remain very risk-averse and, as a result, will only back businesses with an established track record, a good amount of collateral and an almost cast-iron guarantee of future sustainability (and profit).
Coupled with a very strict set of terms and high interest rates, bank loans are increasingly doing themselves out of a job within the small business sector. Especially as bank loans provide a seemingly cold relationship in comparison to other, alternative types of finance. They don’t come with the added benefit of involvement in the business, years of expertise or long-term obligation; paying off a bank loan literally marks the end of the relationship, until a subsequent loan is required.
Alternative finance, however, offers all of these added extras but is often snubbed or overlooked because of a simple lack of awareness. It’s a typical scenario of knowing it exists but not really knowing what it is or how to access it, so it’s best avoided.
For those more savvy (or informed) family entrepreneurs, alternative finance can, however, be a great way to unlock a whole new world of investment opportunities. And it doesn’t have to mean giving up generations of equity.
Invoice discounting is a great source of finance for those with a short-term funding gap. It simply provides the facility to borrow money against any unpaid invoices owed to your business. You sell the outstanding invoices to a third-party who then collects the debt themselves in return for an interest fee from you.
It’s a quick way of stabilising cashflow in your business – always top of any family agenda; especially when said family are also shareholders.
Crowdfunding can also tick the box for finance with a fast turnaround. And the beauty is that both debt and equity solutions are available. Individuals or consortiums respond to a funding pitch from family start-ups and growing businesses by each offering small chunks of the total finance required. The bonus for families nervous about receiving external investment is that their risk isn’t placed on a single source.
Crowdfunding is a great way to gain exposure for your business, as well as a bank of business knowledge and expertise at the same time. It’s a sound trade-off for a business that has to juggle family opinion on how best to promote and grow themselves without a huge amount of capital to spend.
And then there are angel investors. These tend to be favoured by families who seek a less-risky finance path, but it is not the preferred route for those businesses looking to keep control solely within the family network.
Angel investors are often retired, high-net worth individuals who are looking for more than a financial investment. They are likely to have a vested interest in particular businesses or industries and, because of their understanding of a typical business journey, they are happy to take a long-term view. They will, however, expect to give an opinion on how the business is run and receive a financial pay back when it’s sold.
The benefit of an angel investor becoming involved in a family business is that they are likely to have a genuine interest in its success. The question is whether or not you will be happy to let them become part of the family?
Peer-to-peer finance, asset-backed lending and government initiatives are also forms of alternative finance that can help steer a family business through the challenges of an ambitious growth journey.
All alternative finance comes with the obligatory pros and cons (just like a bank loan) and each will have its place in the business’ life cycle.
The challenge for a family business is ticking all the finance boxes, when external investment isn’t always favoured in the first place.
The goal is to manage success through the generations. The challenge is how to secure working capital, through an investment approach, that will not only develop and enhance a business but also retain control and ownership within the family circle. The chances are that different family members will have a different approach to risk and you will have to agree together how much you are prepared to take in the short, medium or long-term, and how much external involvement you are prepared to accept.
Deciding the most appropriate source of finance is a crucial decision for all types of business, but for a family business, a whole different set of politics can have an influence too.
It is important to consider and understand all funding options, both traditional and alternative, as well as the long-term goals of all family business members before choosing the best solution for everyone involved.
If you’re a family business looking to secure funding for growth but need expert guidance on the range of options available, give us a call on 0203 327 0567 or email [email protected]. We’d love to be a part of the family.