by James C. Schulwolf A radio commercial for a car dealership Son 2: “I’ll be in charge of the service de- illustrates one of the challenges of partment and continuing our family’s reputation financing a family-owned business. for top-notch service.” The purpose of the commercial is to Both sons together: “Our customers can be announce that two sons will be taking over the assured of the same attention and dedication that dealership from their father, who founded the our business has provided since our dad founded dealership and established its reputation. it.” Son 1: “I’ll be in charge of the sales department Dad: “And just remember, if you have any and continue our family tradition of personal atten- problems, you call me and I’ll take care of them.” tion.” (Continued on page 54) 52 THE SECURED LENDER NOVEMBER/DECEMBER 2002 VOLUME 58 NUMBER 6
If you are thinking about making a loan to this The key: draw as wide a circle as possible and interview as business, what are you to make of all this? Are the sons many people as possible. independent of the father? Does the father still run the show The interview process will ideally also yield another even though he’s “retired”? Who’s in charge here? important, less-tangible benefit: The lender will be able to Determining who is actually in charge is just one of make a well-informed judgment about whether he or she the factors lenders must take into account when financing a has confidence in the company’s principals and their family-owned business. The key point to keep in mind is management skills. that family dynamics affect the operation of the business — and vice versa. Financing a family business comes down Fundamental due diligence: What you need to know as a to a basic but all-important concept: If you don’t know the lender family, you don’t know the business. In addition to normal financial due diligence regarding the Often, the simplest configuration for a family business itself, the initial investigation must include the business involves a scenario in which the founder is still following areas of due diligence: ➤ Determine who actually owns the company and firmly in control. As the business evolves and passes through generations, however, layers of complexity often whether ownership interests are voting or nonvoting. emerge. Siblings may vie for control, nonfamily company Also, determine the number of minority or nonfamily principals struggle for dominance, less-ambitious family owners. ➤ Take a careful look at each involved family member. members may be living the good life at the company’s expense. Make an assessment of the leaders, the key players, This article provides the lender the necessary tools to and those merely in the business and collecting a understand — and successfully finance — the family paycheck without making a professional contribution. ➤ Determine how much money family members are business. It includes recommendations for due diligence, critical areas of inquiry, such as analyzing family loans, taking out of the business each year in salaries, salaries and expenditures, and a look to the future, includ- bonuses, business expenses (legitimate or not) and ing succession planning and insurance policies. other expenses charged to the business. ➤ Investigate whether a shareholders’ agreement or a As a starting point, to know the family and know the business, a lender must talk to as many family members as buy-sell agreement exists and the terms and funding possible, even minor players. Chances are, most will have for those agreements. ➤ Look at estate-planning techniques that have been something to say about the inner workings of the business and the family. Another key information source are “trusted employed. ➤ Investigate who owns the assets, both personalty and advisers” — attorneys, accountants and other professionals that serve the family. Some may be strict loyalists and real estate. ➤ If multiple generations are involved, determine who divulge only the barest information, but others may provide a more comprehensive picture. really runs the show. And, similar to any other business inquiry, lenders (Continued on page 56) will also want to interview suppliers, vendors and others. 54 THE SECURED LENDER
➤ If children or grandchildren (or nieces/nephews, etc.) Key financing issues are working in the business, determine whether they Personal piggy bank or well-run business? The next step is have had any outside experience or whether they to analyze key financing issues and determine if the current have spent their entire working lives at the business. situation is acceptable. ➤ Determine if a succession plan and its details are in In short, the lender must determine whether the place, as well as any insurance policies in effect for business is a personal piggy bank or a professionally run key players. and managed enterprise with legitimate expenditures. ➤ Investigate whether any skeletons exist in the closet If too much money is being taken out of the business, relating to either the family or the business. — through inflated salaries, bogus expenditures, sweetheart leasing or other deals — the business may be The lender must uncover potential pitfalls and deal unfinanceable. The lender must keep a close watch on with them up front. Some examples of certain conse- expenditures, track the company’s cash flow, and carefully quences that may result if due diligence is not conducted review the company’s reports and accounting controls. include: Salaries, expenses, leases and distributions: When ➤ Poorly planned funding of a buyout can put the the spouse of a family business owner who had recently business in a serious bind, either unable to live up to sold his business was asked how he was enjoying retire- its buyout obligations or forced to fund and end up in ment, she replied, “He loves it, but he just can’t get used to default. the idea of having to pay for his own gas.” ➤ If individuals own the business, require their guaranty Many owners view the family’s cash flow and the and secure it with a pledge of their ownership business’s cash flow as interchangeable and operate as if interests. If the ownership is held in trust, however, they are one and the same. As a result, many expenses consideration becomes a major issue and must be which are really personal and not business-related are addressed. charged to the business, and creative arguments are used to ➤ If there are minority owners, they may have rights justify them as business expenses. The following chart that can frustrate the financing and ongoing operation illustrates the point. (Continued on page 58) of the business. 56 THE SECURED LENDER
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