By Melanie Stern with Eugene O'Malley

We have all received unsolicited letters, from third parties, in distant places, offering all the right words and terms to buy your company including the willingness to close within 90 days. Most of the time, this letter is improperly addressed, names/titles are misspelled, and few details are known about your business. Your typical first reaction is: Who are these people, and what makes them think our company is for sale? Your second reaction is to immediately feel violated, crumple up the letter - hurdle into the nearest trash receptacle, and forever have a very negative impression of private equity firms and the funds they represent. The follow up calls, many times months later, further aggravates the family members and their staff managing the business.

Smart family owned businesses proactively utilize private equity to their benefit. Management's ability and strategy for proactively sourcing private equity funds and identifying the right Private Equity partner is critical to helping the family expand their business and manage risk through well-timed and well-structured capital infusions.

Let's take a moment to review a family business focusing on how private equity can play a role. Active members of family businesses generally have intimate and extensive knowledge of their industry, products, distribution channels, competition, pricing, and markets. They are always seeking ways to expand their businesses while retaining control. Historically, family business growth can be attributed to utilizing free cash flow and bank loans. The world is always changing - there is steady global competition, in almost all industries. Business growth, through market expansion of existing products and services, or through acquisitions, has increased the need for external capital infusions to make it happen. Reconciling the growth and control dilemma is complicated, and many times financing options appear to be narrow, but quite the contrary, enormous amounts of capital options are available that can fit in an environment where maintaining control is the only acceptable option. Many, non-progressive families have a negative view of private equity, and the use of outside equity capital is never properly explored and evaluated.

Melanie: How can proactive Private Equity help family-owned businesses that are seeking growth?

EO'M: The family often has many opportunities to grow their business in their own sector and through expanded products/services. These opportunities can become available in the form of sole source offers to acquire companies from a seller who have known the family for many years and is seeking a "quiet sale" to a sector participant. From a seller's standpoint, this approach is often much more desirable than having to deliver full disclosure, (sacrificing financial privacy), to a multitude of strategic and financial buyers through an auction process that may or may not ultimately produce a viable buyer. Unfortunately, many of these sole-source buying opportunities are lost because internally generated capital may not be readily available to finance the acquisition.

Melanie: What other uses of Private Equity can be helpful to family business owners?

EO'M: Many family owned businesses seek new markets outside of their immediate service area, as well as in emerging markets, to grow their business. After proper investigation of the private equity sources, the capital can be instrumental in financing the family's entrance into new markets, while retaining control of the business and, effectively, sharing the risk of the proposed market entry. Private Equity can provide acquisition capital both in existing, new and emerging markets.

Melanie: How would you develop a strategy for incorporating Private Equity into a typical family-owned business situation?

EO'M: First, I would incorporate new capital into the long-term plan of the business. This plan may include potential acquisitions in both domestic and new markets. I would then begin investigating the Private Equity market for the right partners. Preferred partners may have longer-term investment return horizons and may be able to structure transactions that meet the family's objectives with respect to the family's strategy and timing. We would spend time with the private equity managers in order to develop chemistry and explore deals structure options. Options encompass many variables, and should include, at a minimum, rights of first refusal and the ability to continuous control the family business.

Melanie: Are there funding sources more appropriate for family businesses?

EO'M: There are numerous sources and each can play a valuable role to the family. For example, if a short-term opportunity was presented to the family that had a two-year horizon, then possibly a hedge fund might be the answer. Three years ago, a family owner asked my firm for assistance in acquiring a "sole source" privately owned business that had multiple businesses, but the family only wanted one of the three businesses. The two families came together to discuss the acquisition, values and opportunities. A plan was developed and put in place, whereby, both families benefited from the available assets. We were able to organize "rapid acquisition" with an infusion of hedge fund capital and, upon completion, took 100% control of the desired business and proceeded to independently sell the remaining operating redundant assets to separate external parties. The selling family maximized the liquidity of their businesses, and the acquiring family got the asset they sought at a "fair price." The selling family was spared the auction due diligence, while maximizing the realized value - which was their primary reason for going "sole source" in the first place. All of this result was achieved due to the infusion of outside capital to finance the transaction. Yes, it possibly could have been facilitated internally, but the acquiring family did not have the capital ready, willing and able, to execute.

Melanie: What about longer-term capital in the Private Equity market?

EO'M: Many of the insurance companies have private equity allocations that fit very nicely with families seeking to control their business and expand. Insurance companies have long-term balance sheet obligations that they can potentially match with family owners expansion capital needs. Insurance company financing structures can be long term fixed rate notes with a small warrant position. This approach works well in the situation where the family is looking for more patient money with less dilution. The offset is that insurance companies generally seek less risky transactions than other sources of private equity capital.

Melanie: How will a family "exit" their investment relationship with a source of private equity capital?

E'OM: Depending on the how the capital is utilized, it can be "refinanced" at a later date after the business has grown and presumably has a higher valuation, or the exit can take place from the sale of a business if that is part of the strategy. I had one situation where both the family and the private equity provider sold a business they acquired together because they received a very interesting offer to exchange the business for public company shares at a valuation that could not be refused. The business had grown rapidly and the new buyer wanted the company as a platform for consolidated growth. Both the family and the PE fund sold, the public firm share price grew rapidly and the family achieved extraordinary tax deferred returns and continues to hold the shares today.

Melanie: Are there many families using proactive Private Equity?

EO'M: Yes, the families I know that are using private equity have some of the following characteristics:

They are globally minded and use private equity to enter new markets through acquisitions. They establish multiple levels of ownership structures but still remain in control. The families know their business extremely well, know where the opportunities are, are open to being presented opportunities, have determined that their ability to manage risk, and planned expansion cannot be achieved by merely employing internally generated working capital! They have been aggressively seeking and evaluating opportunities to help grow their respective businesses.

Melanie: what would you suggest to families who need to investigate private equity.

EOM: Families should work diligently to develop plans with, and without, external capital to help quantify the pluses and minuses of infusing external capital to fuel business growth. Also, it helps to be open-minded to developing and investigating relationships that may have favorable partnering characteristics. Many times, this may mean a relationship in another country. Certain private equity funds seek longer-term relationships to employ capital. Many sources of private equity would prefer a relationship where multiple transactions will potentially take place over time with a competently managed family that understands how to successfully run and grow its business. The management of the family business should commit the time and resources or obtain assistance to pro-actively investigate this substantial pool of available capital as the benefits and results can be quite significant to the family.

EUGENE F. O'MALLEY is the managing partner of Cobblestone Advisers LLC www.cobbleadvisers.com, an investment banking firm based in Boston, Massachusetts. Mr. O'Malley can be contacted at (617) 443-9500 or

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