Family Business Owners' Financing Decisions

This article explores some of the issues and explains some of the funding options taken by family business owners.

Family businesses in Australia, and for that matter elsewhere, have a major impact on the growth of economies through the generation of employment, productivity, and innovation. Although there has been considerable interest in family business in the past decade, little is known about the factors that influence funding decisions of family business owners. It is common knowledge that a complex array of factors influence small-to-medium size enterprise (SME) owner-managers’ financing decisions, but it’s not known which factors explicitly influence family business owners’ decisions on the choice of different forms of finance such as debt, equity, family loans, or securities.

Traditional Sources of Capital

Anecdotal evidence suggests that family business owners typically reinvest most, if not all, their funds during the early stages of the life-cycle of their business. However, in later years, owing to families’ growing financial demands, owners tend to use their company’s profits rather than reinvesting capital for additional growth. This is primarily because owners of family businesses are averse to sources of capital that are beyond traditional commercial banking arrangements such as investment and venture capital, initial public offerings, funding through general finance companies, and access to state and local funds. Creditors also tend to restrict family business owner’s flexibility and prerogatives by stipulating rigid terms regarding capital structure, and such covenants have culminated in entrepreneurs being apprehensive about loss of control. Thus business ownership and family control factors play a large role in owners’ financing decisions.

Low Debt/Equity Levels

Family businesses also tend to have low debt/equity levels, particularly where firms are market leaders. They have low debt/equity levels in order to avoid damaging their family’s reputation and personal guarantees, and losing everything in case of loan failure. On the supply side, financial institutions seem to place a heavy reliance on wealth rather than repayment capabilities of family businesses, thus size of family firm is closely associated with use of multiple financial institutions and diverse financial products for financing.

Capital Needs

In many instances family business owners make decisions that take into account a conglomeration of competing management, family, economic, market, and industry considerations. The capital needs of a family business can be satisfied in a number of ways:

through internally generated cash flows;
additional capital injections by current shareholders;
by broadening the circle of shareholders (either through a share float or by inviting employees, directors, or investment institutions to buy shares);
through loans from insiders and/or third parties; and
by selling parts of the business that do not belong to the core activites of a firm.

In summary, the factors that influence family business owners’ capital structure decisions include:

entrepreneurs’ prior experiences in capital structure;
preferred ownership structures (e.g., employee stock options);
use of internal financing (e.g., to clear debt);
views regarding control,
debt-equity ratios, short- versus long-term debt;
age of firm;
perceived key sources of funding for growth (e.g., retained earnings versus debt);
attitudes towards debt financing; and
perceived risk.

George Tanewski is Senior Research Fellow in the AXA Australia Family Business Research Unit at Monash University. Dr Tanewski writes extensively on family business issues and also sits on the board of a prominent Melbourne family business. For further information please contact George Tanewski on (03) 9903 2388 or george.tanewski@buseco.monash.edu.au
First published: 21 February 2001.
Last updated: 6 October 2005.