The family business invariably grows from a single operating company. As the original business grows and matures, throwing off tremendous amounts of cash, the question becomes: what next? There seems to be three main strategic ideas: 1. Grow the same business geographically, 2. Financial investment programs or 3. Enter into new businesses locally. These strategies are not mutually exclusive.
Growing the same business geographically makes eminent sense. It allows a laser focus on a business that management understands, but growth beyond the boundaries of the local market. The Alshaya group of Kuwait is a good example of this strategy being executed well.
The second strategy of financial investment programs requires a whole new team and department, at least if one wishes to be successful. The basic reasoning for these programs is that they can give near instantaneous sector and geographic diversification. The Olayan group of Saudi Arabia have successfully deployed such a strategy both regionally and internationally, on a massive scale.
The final strategy of entering into new businesses is more difficult. Different businesses require different expertise from the original business. Furthermore new businesses are, by definition, at the opposite end of the risk spectrum from established businesses. The risk tolerance of the original business executives is not going to be sufficient to monetize new opportunities. For these reasons it is difficult to find successful examples of this strategy working well. Warren Buffet’s Berkshire Hathaway is a good international example.
For the basic family business, the first strategy, geographic expansion, makes sense as it directly leverages the group’s core strengths. It of course makes sense to diversify, but not too much and not too soon.
In terms of financial investments, they do indeed give good diversification, but it is usually in areas that the family group has no expertise. Even if the family business can deploy a program that creates value, or generates ‘alpha’ in investment lingo, does it make sense to focus on this? Or does it make more sense to focus on diversification via exposure, or ‘beta’ in the lingo, and keep management focus on where it can add alpha, local businesses?
The greatest potential for growth lies in developing or acquiring new businesses. The perceived risk is high, but the actual risk not as much. The first reason one might think about acquiring new businesses unrelated to the original business is to leverage the skills and expertise of the new management.
One example is geographic expansion. A family business that has already learned to expand its original business into new countries can leverage this expertise by expanding other businesses. A mature company in the local market might look unappetizing from a growth perspective, but would be perfect once viewed from a regional perspective.
Another example is unlocking value. The frontier and emerging markets of the region include massively inefficient companies that hold value which can be unlocked relatively easily. Rather than give their money to private equity firms, these family businesses should continue to act as private equity firms.
This operation value creation is driven from the board of the new companies, where value can only be unlocked by proactive leadership at the board level. This, in the end, is how business is influenced, not by holding 51% or more of the company’s shares. To succeed with this ‘Buffet’ model developing or acquiring the skill set and risk taking attitude is critical.
Initial attempts at deploying such a strategy have failed predominantly due to flaws in the design of the business model. The main one has to do with the required risk tolerance of management. Current groups all too often mix management of the existing stable business with management of the new venture unit.
This initially might seem to make sense as the stable businesses are deemed to be able to provide support and expertise to the new businesses. This masks the issues that management of the stable businesses need to be risk averse, protecting value, whilst management of new ventures need to be able to tolerate high amounts of risk to grow new companies. The successful CEO of the large stable business will all too often stifle the risk taking necessary for new ventures to succeed. This is ironic as the founder of the business usually will be a risk taker for having built the business in the first place.
The second issue is that the management style differs. Operating managers work within a narrow focus, and their skill set is running a business.
New venture investors need to learn to move fast, opportunity is fleeting. They need to push to unlock value. They need to be entrepreneurial leaders.
To this end it is important to build a culture whereby the internal private equity team can interact and contribute to the group in a meaningful way. To quote Warren Buffet from his 2014 newsletter: “I’ve mentioned in the past that my experience in business helps me as an investor and that my investment experience has made me a better businessman. Each pursuit teaches lessons that are applicable to the other. And some truths can only be fully learned through experience.”
In the end, family businesses are slowly feeling their way to the Warren Buffet model. A core well run business that is a cash cow, coupled with a focussed and concentrated operational investment approach. Founders might feel a nostalgic connection to their first business, but most probably they yearn for the entrepreneurial challenge and reward of the new venture.
This article was originally published in The National.