Financing family businesses

 

May 2002

Financing has remained a problematic area for owner-managed businesses in Malaysia. This was reflected in a recent survey jointly conducted by the Malaysian Institute of Management and Shamsir Jasani Grant Thornton.

With the pressures of globalisation and new technology fast setting in, many family businesses face the harsh reality of having to revamp themselves, improve facilities and upgrade their human resource skills and competences if they are to stay competitive. All this requires funds. However, family businesses are generally relatively small and uncertain in profit sustainability. Thus they often find limited avenues to obtain funding for their businesses.

The survey also found that the majority of the small and medium family businesses use mainly family funds for business development. They rely less on funding from the financial institutions than the larger enterprises do.

There are a number of reasons for family businesses to confine funding to only family members. One is their concern about losing control if they were to involve outsiders in financing the growth of their businesses. In fact, more than half (62%) of the small-scale enterprises surveyed expressed this concern.

Another reason for family businesses' not seeking funding outside the family has to do with their founders. They generally lack the technical education, first-hand knowledge and experience in securing financing. As a result, they face difficulty in obtaining the necessary funds and are often unaware of the availability of the many government-assisted fundings.

As growing a business requires continuous funding, the founders need to overcome their weakness in and their attitude toward financing. They need to acquire a good foundation in financial management. This will enable them to understand the risks and trade-offs to look out for as well as how much money to get and from whom. Developing a fund-raising strategy and obtaining funding can be a hazardous task. It can commit the company to actions that incur costs and consequences that may enhance or inhibit future financing efforts as well as the stability of the company. Each source of funding has particular requirements and costs, both apparent and hidden, which have serious implications for the future of the company. Also, the availability, the amount and the cost of each source of funds will depend on the stage of the company's life cycle and the potential of the company.

Sourcing equity funds

Usually, funds from family and close friends will become insufficient to meet the financing requirements generated beyond the early stage of a business. Giving up part of the control of the business may be a small price to pay in exchange for business growth through injection of equity funds from outsiders. However, founders of businesses are often at a loss as to where to find these investors.

In Malaysia, as in most other countries, there are many high net worth individuals who are looking for ways to invest their surplus funds. They could be professional advisors, business acquaintances, past employers, customers, suppliers, and professionals like doctors and architects. These investors are an important and suitable source of fund for the development stages of high potential firms and the early stage financing of medium-scale family business firms. Unlike venture capitalists, they are not that rigorous in their evaluation and stringent in their requirements, especially when investments are only between RM50,000 and RM500,000. Most are prepared to invest in a business on the basis of personal relationships with the founder or if the founder can convince them of the potentials of the business.

To widen the access of family firms to these investors, professional firms like accounting and legal firms may consider maintaining a register of their wealthy clients who are interested in such opportunistic investments and match them up with businesses looking for sources of equity funds.

In the US, these wealthy individuals, who invest more or less regularly in start-up or early growing firms are called “angels”. Many of these “angels” have become millionaires from their investments in family firms which have grown into sizeable firms like McDonald's, Hewlett Packard, IBM, Apple and Microsoft. If the government is convinced that family firms are an important engine of economic growth, it will examine ways to spawn the growth visibility of similar “angels” in Malaysia like it is doing for venture capitalist firms.

Problems in sourcing debt financing

There are cases where the founders, unwilling to sacrifice part of the equity to outsiders, actually finance their business with a great deal of debt. While this may be possible although unlikely, it is unwise to do so. A new and growing company is a consumer of capital and can ill afford to make regular payments of interest and principal required with debt financing. Many businesses that are heavily debt financed find themselves constantly undercapitalized and have continual cash flow problems. These problems will doubtless occupy the time and attention of their management to the detriment of the development and growth of the business.

Many new and growing firms in the survey also expressed the difficulty of obtaining finance facilities from financial institutions, especially in the first three years of their existence. This probably explains why some of the small and medium-scale businesses in the survey rely less on funding from financial institutions than the large-scale enterprises.

The Malaysian government has over the years established numerous funds and grants to help small and medium-scale firms commercialize their research and development, improve their competitiveness and develop new markets in emerging countries.

Yet, many family firms, especially the small and medium-scale in the survey, complained about the problem of securing funding for their businesses. This could only suggest that they are not aware that these funds and grants are available to them. Or they have difficulties making out their applications to comply with the processing procedure. Or it could even be that the approving criteria are too stringent.

This suggests that the governing agencies administering these funds and grants could help by reviewing their application and processing procedures and approving criteria and making them more customer-friendly. Ways could be found to educate the family businesses on the availability of these grants too. On the same note, the chambers of commerce and other trade associations might organize seminars to inform their small and medium-size members on these funds and grants and possibly train them to evaluate their eligibility and how to make out their cases to get these funds and grants.

Some family firms also complained of delays in getting their applications processed by financial institutions. Some had had their applications rejected. Bank Negara Malaysia's initiative in requiring banking institutions to publish a Client Charter goes a long way towards facilitating family firms in applying for loans to finance their business. The Client Charter, which stipulates the documents and information needed by banking institutions to process a loan application, also includes the eligibility criteria for obtaining loans, the definition of project viability and the time taken by the banking institutions in processing a loan application. This will make family businesses better informed and adept at providing the necessary information to expedite the processing of their loan applications as well save them the bother of applying for loans that will not be approved.

Small to medium-size industries (SMIs) are among the driving forces in the economic growth of a country. They provide important linkages to export-oriented industries and are often the predecessors of big successful firms in addition to providing employment to a large portion of the workforce. Therefore, SMIs, particularly family firms, should not be handicapped or starved in securing funds, a key resource to business growth.

Government initiatives and efforts by the chambers of commerce and business associations are important approaches which will help to eliminate a key hindrance to the progress and growth of the family firms among the SMIs. Indeed, such support should be sustained if family firms are to contribute significantly to the country's economic growth.

You are welcome to contact the writer
Mr Lim Yew Meng at e-mail: ymlim@mim.edu