Family businesses are prolific in traditional sectors like construction and the car industry, but many will later diversify into high-tech businesses outside of their core activities.The reasons for doing this, and the way in which they do this, are often different from other types of investors, like venture capitalists and business angels. Sometimes families are just pursuing an opportunity to make money and diversify their financial portfolio in the same way as these other investors, but there are often other motivations that are unique to family enterprises. Some will decide to diversify their enterprise and change direction to match the skills or interests of their successors. If the next generation has made it clear that they do not want to take over the business started by their ancestors, but the family still wants to remain in business together, they need to diversify. The catalyst might also be the desire to give the next generation an opportunity to pursue their own business ideas and to learn what it is like to establish and grow a business. These families believe that the best way to learn about business is to run your own. Note however, the clear difference between a strategic decision to invest in a particular technology, and investing in the ideas and talents of a family. It is not so much that the family chooses, for example, energy over telecoms for strategic business reasons, but that their offspring have ideas as to how to develop the energy market. No doubt financially astute families will consider the financial risks of such a decision, but the family’s investment will be partly because they feel easier about investing in the high-tech ambitions of a relative compared to backing strangers. This attitude has potential advantages and disadvantages. The main advantage is that the family often invests on favourable terms and are prepared to wait longer for the return on investment because they are investing in one of their own. But the downside is that this may inadvertently reduce the drive to generate a return and the family’s patient capital is exploited unfairly. Potential failure? Then what happens if the investment does not work out as planned? Will the family be forgiving because they had accepted the commercial risk of failure, and because they are less likely to criticise a relative? Or will failure lead to strained family relationships and put more than money at risk if the investment flounders? The family’s reaction to failure depends on their innate attitude to risk. They may be naturally conservative and concerned about preserving, or not losing, wealth, which is an attitude common among those who have inherited a fortune. For them, high-tech investment in support of a relative’s entrepreneurial ambitions is fraught with the risk that failure may lead to feelings of shame and then to broken relationships. Therefore, it is wise for families who seek entrepreneurial growth to agree how to value the emotional capital they are investing as well as structuring the financial return. Diversification fund One family decided to address this by setting aside money to encourage the family’s new ventures, but they also adopted a value that they called “second chances.” While setting clear expectations in relation to the amount of financial support available for investment and the desired level of return, the family acknowledged that it was unrealistic to eliminate the possibility of mistakes being made. When, rather than if, an investment did not work out as hoped, the family were all expected to learn from the mistake and apply this learning in demonstrating growth and choosing not to repeat the same mistakes. Another family’s approach to high-tech investing was to raise a fund that would support ventures into new technologies that either might be useful to the family’s core business or could benefit from the core business’s other resources, such as access to distribution channels and international trade connections. The fund was the idea of two family members who wanted independence to do something on their own while remaining useful to the core business. They needed to do this in order to pursue their own aspirations while dealing with their feelings of loyalty and duty to their family of origin. Family members were invited as individuals to invest in the fund but always on the same terms as external investors, and it was agreed that the family business itself would not be an investor. The business would support companies in which the fund invested, with the infrastructure including incubator premises and access to the business’s network of contacts. If any of the investees produced technology that would be useful to the business they would seek to obtain a licence or even acquire the start up. By doing this the family was in some ways outsourcing some research and development. As with any business decision, the potential commercial benefits – and risks – of diversification must be weighed up by all stakeholders, and the repercussions considered. What can start as a financially-motivated decision can soon morph into one which impacts on far broader relationships and individuals, so needs the full research and planning expected of any start-up business. Ken McCracken is founder and a family business consultant at Withers Consulting Group.
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