Untangling the web of family business finance

In family business, financial management can get especially tangled and accessing loans can be trickier. Knowing what the banks are looking for can make the process less painful.

Family businesses are complex so not surprisingly, raising funds and financial management in that sector is more complicated and messier than it is for normal businesses.

Unlike other businesses, family businesses have an ordinary business system working in combination with family systems. Add to that the impact of individuals in the business and the family’s vision and passion, the stuff bankers can’t put a value on but which is the backdrop to every family business.

The problem is banks these days are reluctant to lend against cash flow, they want assets. One successful family business started up years ago when they mortgaged five family homes. Or take the case of Spring Gully Foods, which had to mortgage all its debtors and directors’ houses to get money from the bank (How Spring Gully got into, and out of, a pickle, May 30).

Think of how messy and entangled that makes it, or of the potential family tensions it could create. It’s not an uncommon story. Managing this is a challenge for every family business.

What makes it more complicated is that different members of the family will be at different stages of their life cycles. Older family members may be looking for security and low risk, whereas younger ones may be more inclined to keep investing in the business to keep it growing. The family business will have to balance different drivers to raise funds.

That said, family businesses prefer to grow steadily rather than expand rapidly. As a result, they tend to have lower gearing than other businesses. When they do take out loans, they tend to use collateralised forms of finance, such as bank loans secured on property (primarily residential), as well as lease and hire purchase transactions.

Simon James, a partner at HLB Mann Judd, a firm that specialises in the family business sector, says most family businesses are more conservative and not that highly geared. “It’s more real and personal, they need more visibility over their income on a weekly or monthly basis.”

The banks too, he says, are more conservative.

“You don’t get many highly geared family businesses because the banks just won’t lend against it because it’s too risky.

“They’re not lending against the family business. They might be lending against the owner’s house but that’s it.

“You don’t see many highly geared family businesses, they have to rely on their cash flow.”

He says banks now expect the family business to have some asset backing behind them, and they don’t care where it’s from.

James says: “Have they any personal guarantees that they can give, a parent or family members that is prepared to guarantee loans?  If you have the security, they’ll grab everything they can get into their net to protect themselves. And you see more of that in the family business space than the SMEs.”

And there lies the problem: family members who are not running the business can end up guaranteeing loans. That ensures things can get very messy, increasing the politics and tensions within the family business. That is something that every family business needs to work through. But the banks, says James, insist on getting that security.

“The problem is once the bank has some type of security, unravelling it is ridiculously hard.”

In that sense, the banks are essentially like trams operating on a track, there’s no deviation. Businesses wanting loans have to tick the boxes.

Finance broker Wade Oldham, who services mostly family businesses, says the big issue with family businesses is disentangling the different parties. But he says it can be done by focusing on the ones who are on the front line.

“What we try to do is make sure those involved in the business have their head on the block, so to speak,’’ Oldham says. “And banks by their nature don’t give up and they don’t help people disentangle.”

He says the entanglement is always the complicating feature in the financing of family businesses. “It’s not always possible because sometimes they are so freaking tangled, it’s not funny.’’

Banks are also focussing more on succession planning and governance as risk issues, a vulnerable spot for family businesses, with a Family Business Australia – KPMG survey finding that more than half of the surveyed firms had no board or governing body, formal or otherwise and only one in three had a family council, three quarters of them failed to do any independent review of their management team’s performance.  Similarly, the vast majority in the survey did not have succession plans for control of the business in place.

The banks take all of that into account, although not having them doesn’t necessarily stop the company from getting a loan.

Cindy Batchelor who heads up business banking in Victoria for NAB says:  “When we look at how we are going to support a business, we will look at all those things holistically but in terms of getting credit it’s on a case by case for every business.

“There are three things we look at but they are not different because they are family businesses – the first thing is the character, their history and track record, the next piece is what the projected cash flow looks like and finally is there any collateral or security they might put up. It’s not different because it’s a family business.

“It’s just to get a sense of why they are in business. Are they looking to grow the business, are they looking to hand it on to someone in the family?  It’s not a deal breaker but it’s prudent to think about where the business is actually going.”

ANZ general manager for business banking Michael Rose says the question will be asked although the loan doesn’t depend on it. What the bank does instead, he says, is try to work with the family business to resolve the issue, perhaps working more with the accountant or lawyer or setting up special sessions with professional firms to talk about it.

“Governance and succession is increasingly a big issue for family businesses,’’ Rose says. “This is where the risk issues come into play. We take it into account but it’s not a knockout. Any good relationship banker would ask the question because we are genuinely interested in the succession of the family”.

As more family businesses apply for loans, the banks will be putting pressure on them to professionalise. For the family business sector, it will be a massive sea change.