While seizing growth opportunities can be exciting, it may introduce some unique complexities for the family enterprise.

Family dynamics can have a big influence on what requires additional capital, when it’s needed, and how it’s accessed and deployed. As we discussed in the kickoff to this series, establishing a formalized governance structure prompts the business to align on the ‘what,’ ‘when’ and ‘how’ in advance. Not only can this prepare the business to seize new opportunities with confidence and agility, but it helps ensure the needs of the business are balanced with those of family members.

“Being prepared for the capital needs of your business almost always leads to increased strategic flexibility,” says John Deering, Leader, Deloitte Capital Advisory. “It’s a good way to know an optimal solution can be available when you need it.”

Traditional and nontraditional lenders are expanding the spectrum of funding choices

In the past, family enterprises had few options for accessing capital. As a result, they largely relied on traditional commercial banks. Unfortunately, commercial banks often took a conservative stance and restricted how funds could be used, thereby limiting what a family enterprise could achieve. While the debt markets have since evolved to include new, nontraditional lenders, many family enterprises are not aware of these options.

“The private debt markets have rapidly evolved, and today there are a lot of versatile, creative, non-bank alternatives to fund a family enterprise’s capital needs,” Deering says. “They can also provide more flexibility, including the ability to add on to credit facilities or refinance as conditions change. A common theme when evaluating debt alternatives is finding the optimal balance on cost vs. flexibility.”

The commercial lending landscape has seen business development companies (BDCs), hedge funds, insurance companies, and mezzanine funds play a more significant role in capitalizing private companies in recent years, accounting for a majority of all private leveraged finance transactions. These emerging players are providing creative capital structures to pursue acquisitions and other growth initiatives, accelerate capital expenditures to fuel organic growth, fund special dividends, buy out minority shareholders, or restructure debt to eliminate existing, potentially restrictive financial covenants.

BDCs are a noteworthy non-bank lenders as they have emerged as a compelling vehicle for accredited and institutional investors looking for an alternative to public equity and debt markets. With record amounts of investible funds, or “dry powder” being raised, BDCs have become a popular choice among middle market companies seeking first lien term loans, unitranche financings, subordinated debt, structured equity, and equity co-investments.

Private equity funds have also emerged as an important alternative when evaluating long term capital needs and shareholder liquidity goals. Like BDCs, private equity funds also have large amounts of dry powder. There was roughly $1.3 trillion in uninvested private equity capital as of September 2021, and fund managers are under increasing pressure to deploy it in fresh opportunities. However, rising deal values by private equity is a key theme in looking back at 2021.

“The big story will be when private equity took over as the driving force for M&A,” says Phil Colaco, CEO, Deloitte Corporate Finance LLC. “In 2021, private equity funds were paying higher multiples than strategics, which I’ve never seen in my career. The rise in the past year of private equity backed deals has been astronomical.”

The following chart demonstrates the various types of financing sources driving competition and flexibility across the private debt markets, as well as how this competition yields a range of structural creativity and pricing dynamics.

The importance of a capital needs assessment

The proliferation of capital solutions is certainly good news for family enterprises, as it affords them greater creative license; however, proper timing is an important consideration to take full advantage of these options, as both internal and external factors play a role.

Within the business, leadership transitions, pending distribution requirements, and major initiatives may help determine the optimal time to execute a capital acquisition. Likewise, environmental factors such as economic trends, the political landscape, and workforce issues are also key considerations that can elevate one solution over another at a moment in time. Also, companies should factor in the time it takes to build key relationships with funders.

Just as an owner spent time building a relationship of trust with their original lender, it’s important to build relationships to gain access to the non-bank capital providers. This is where a capital needs assessment can help

Where to start

Every capital needs assessment begins with a list of questions. “Proper due diligence goes a long way in setting the family enterprise up for success in this process,” Hughes says. To that end, the business should consider thinking through several questions during its normal governance deliberations, including: