Family businesses show signs of stronger credit quality

Despite differences in size, location and industry, family owned companies have a number of revealing similarities. For many, their longer-term outlook on business strategy tends to result in greater stability.

In fact, our recent study into the creditworthiness of family-owned businesses demonstrates that credit ratings for family enterprises were more stable over the last five years than ratings for businesses with other ownership structures. As bank lending becomes increasingly constrained due to new regulations, and as family run companies seek growth-enabling funding outside of these long-term relationships, this may prove an important strength.

A diverse but small group

In our study, the definition of family ownership requires most decision-making rights to belong to the firm?s founder(s) or immediate family and heirs, and one member of the family to be officially occupied in the firm?s running. Of 784 rated companies in EMEA, ? barring utilities, project finance entities and financial services companies ? only 92 fall within this definition. But this small group contains a variety of different sized businesses, in a number of locations and in a range of industries. 

That said, there are several characteristics that members of the group have in common, despite their diversity. For example, they often plan to pass on the business to their family?s next generation ? giving management longer horizons than is common elsewhere. 

Various studies have tried to understand the effect this behaviour has on performance. For our analysis, we examined the stability of ratings for family owned businesses by cataloguing rating transitions over the past five years and comparing the results to our total rated non-financial corporate portfolio. The results demonstrate that ? over this period ? family owned companies were more stable in all rating categories apart from BBB.

Management and governance is an asset

Broadly, our management and governance (M&G) analysis examines a range of activities relating to supervision and direction conducted by the business owners and its board members, executives, and managers. 

On top of more stable rating performance, our study shows that family run companies generally display stronger M&G scores, with 18 per cent classed as “strong”, versus 13.1 per cent for our rated issuer base. 

Yet our study shows that these companies can be susceptible to “key man” risk, with one figure dominating management. Therefore, the existence of a clear plan of succession is essential, as the loss of key personnel can cause considerable disruption to operations and cash flow.

An assortment of financial policies

Our financial risk assessment is derived from analysis of prospective cash flows and a company’s evolving capital structure. More sophisticated business managers balance the degree of financial risk that they are prepared to accept against the fundamental dynamics of the business, and the financial policy of the owners and their investment horizon is taken into consideration in our overall credit assessment. 

The family enterprises in our study cover a wide range of different financial policy strategies. But even with these substantial variations, 64 per cent of the family enterprises in our study have financial policies we would categorize as moderate, conservative or very conservative. 

This caution ? and resulting stability ? is a vital strength after the financial crisis of 2008, as bank lending lessens and businesses throughout EMEA seek new sources of financial support. The more enterprising family businesses will consider sources of finance outside of conventional banking relationships ? perhaps turning to the debt markets in the process. 

With this in mind, Standard & Poor?s launched its Mid-Market Evaluation (MME) this year. The MME aims to plug the gap in information by providing mid-market companies ? which we define as companies with revenues less than ?1.5bn and outstanding debt less than ?500m ? with an impartial, third-party view of creditworthiness. 

For family owned businesses too small for a formal credit rating, the MME aims to provide a convenient method of conveying their stability and attractiveness to new investors.

Taron Wade is associate director at Standard and Poor’s.

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