One of the hallmarks of family business has been the deliberate accumulation of capital over many years. Two recent developments indicate that the landscape for family capital may be evolving, albeit slowly.
Who Now Qualifies as an Accredited Investor?
On August 26, 2020, the Securities and Exchange Commission relaxed long-standing rules defining who qualifies as an accredited investor. This is significant because only accredited investors can invest in privately placed securities. Since private issuers are not subject to the same disclosure requirements as public issuers, the SEC limits such issues to investors who are presumed to have a degree of financial sophistication and the ability to bear the financial risks that accompany illiquid investments with potentially long holding periods.
One of the stated purposes of the rule change is to promote capital formation for smaller businesses. The practical minimum size threshold for a public securities offering is well out of reach for most family businesses.
By loosening the requirements for accredited investors, the rule change increases the number of investors eligible to participate in private offerings.
What remains to be seen is whether the larger pool of accredited investors will encourage more family businesses to raise equity capital through private placements. We suspect that only family businesses not having a long-standing aversion to non-family investors will be affected by the rule change.
Over the longer-term, however, we will not be surprised if the taboo against non-family capital wanes, and the distinction between private and public companies diminishes.
The Long-Term Stock Exchange Debuts
The Long-Term Stock Exchange (“LTSE”) debuted on September 9, 2020. Issuers qualify for listing on the LTSE under a principles-based approach that would appear to align pretty well with family business culture. The LTSE requires listed companies to publish policies around five core principles:- Long-term focused companies should consider a broader group of stakeholders and the critical role they play in one another’s success.
- Long-term focused companies should measure success in years and decades and prioritize long-term decision-making.
- Long-term focused companies should align executive compensation and board compensation with long-term performance.
- Boards of directors of long-term focused companies should be engaged in and have explicit oversight of long-term strategy.
- Long-term focused companies should engage with their long-term shareholders.
What Do These Two Developments Mean for Family Businesses?
If the near-term impact of these two developments is likely to be limited, why bring them up? Because both developments illustrate how attitudes toward family capital are changing, and family business directors need to be thinking about this shift in perspective.
"... capital markets for family businesses will, over time, look more like public capital markets."
In the past, family business leaders could assume that they would enjoy continued access to family capital. In other words, family businesses didn’t always feel the competition for investment capital that other businesses face. Since the business had created the family’s capital, one could safely assume that the business would always have access to that family’s capital to fund operations and new investments.
In our view, the loosening of the accredited investor definition and the formation of the LTSE are manifestations of a broader trend, which is that capital markets for family businesses will, over time, look more like public capital markets.
The rise of the family office as a source of investment capital for other businesses is the best evidence that families are comfortable looking outside the family business to generate returns on family capital.
Just as liquid naturally flows to the lowest point, capital naturally flows to its highest and best use. The viscosity of family capital is high, so it may take longer to move, but it eventually will.
3 Things for Family Business Directors to Begin Thinking About
In the context of this broader trend, we propose three things for family business directors to begin thinking about.
- Are there growth opportunities available to your family business for which it would be worth obtaining non-family equity capital? Regulators seem to be focused on making such capital more readily available.
- Does your family business provide a compelling case for maintaining its allocation of the family’s capital? In other words, does your legacy business generate sufficient returns to prevent family capital from flowing to competing alternatives?
- What is your family’s overall capital allocation? Does that allocation meet the characteristics, needs, and risk preferences of your family? If you have a family office, does it have a process for identifying and screening potential investments?
