German family businesses & PE: An uneasy relationship

Private equity philosophy and the ideals of family-owned businesses are arguably at odds with each other. Families value the freedom to structure and lead their own companies and to decide what to do with their returns. Private equity investors have often been accused of being money-grabbing "grasshoppers" – a plague of irresponsible animals that hop from one business to the next taking what they can. The phrase was first coined by Germany's former leader of the SPD, Franz Müntefering, in 2004. It is still a term widely used by the country's critics of alternative forms of financing. "It is true," says DZ Equity Partners director Olivier Weddrien, who spoke to unquote" at the Foundation for Family Business's German family business day. "When I talk to entrepreneurs here over lunch one message is clear: they are rather sceptical of private equity because they have had some negative feedback from companies that experienced a partnership."

Partnerships between family businesses and private equity are relatively rare in Germany and that may not change in the near future, says Christian Niederle, managing partner at corporate financier Network Corporate Finance: "Firstly, the willingness to sell won't increase dramatically because families are still suspicious of private equity and they've worked hard to build up capital resources and may not need further investment. Secondly, as the banks' readiness to provide loans will not increase in the near future, obtaining the finance required will be difficult for private equity houses. I think both sides face barriers to forming partnerships."

The problem, according to Niederle, lies with a closed loop situation: private equity houses want profitable businesses with good capital resources in order to drive growth in the absence of leverage, whereas these companies are less likely to need investment. Weddrien agrees that there won't be huge changes in the field, although he says internationalisation offers opportunities: "There will be more partnerships because you have to consider that big economic growth does not happen at home anymore, it happens in the emerging markets. Innovative German family businesses will have to establish an international presence. That in turn demands management experience in these markets and money to invest in value creation."

On top of that, Weddrien suggests, banks have sought to reduce their lending books and this makes it difficult for businesses to draw funds through loans, especially when doing business abroad. Private equity firms with a global presence could move in to bridge the gap. "I think private equity houses with emerging market offices and teams that can assist businesses locally have indeed got a very bright future as partners of mid-cap German businesses," says Weddrien. "But only if they learn to speak the language of mid-cap business and try to understand its interests."

The importance of a proper alignment of interest when dealing with a family business is something Weddrien knows well. When his firm DZ Equity Partners bought a stake in Austrian electronic equipment company Electrovac from Bank Austria Private Equity-Fonds UBF in 2007, the first successful deal suffered from a clash between the owners and the partnership had to come to an end. Weddrien says: "A partnership gets in trouble when the two players haven't agreed on where they want to take the business before signing the deal, but also when the family business takes the equity for easy money because every private equity house wants to have a say in the development of the business, in particular the strategic planning." But when a common ground is found, Weddrien says a private equity and family business partnership is a good fit: "For me private equity is a sensible choice for family businesses because usually private equity brings increased efficiency, turnover and profits. It also takes a vital role in developing the business strategically." Niederle agrees: "As long as the business goes well there is no downside. The only problem is when the business does not develop as well as one envisions."

DZ believes it is in a more suited position to partner with family businesses than conventional private equity houses. DZ Private Equity – the investment company of DZ Bank AG, a central financial institution of the cooperative banking group – gets its funding directly from the banking network. It is not dependent on closed-ended funds and therefore it is more flexible with its investment strategy and can focus on long-term horizons and corporate development of its portfolio companies. Although other private equity houses may try to follow suit and invest in longer terms, Niederle believes "the mass will have to stick to a time frame of five to seven years because the LPs that invest in the funds have certain return expectations and time horizons". This relatively short timeframe can be off-putting to family owners.

Both Niederle and Weddrien agree that new family business owners will be more open-minded towards alternative finance. "The new generation of entrepreneurs is not the founding generation. Often they were educated internationally and had management positions abroad before taking over the family business. They can be more open-minded towards external financing," says Weddrien. But his outlook remains conservative: "There will be cases and they will become more common but there won't be a surge."

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