Pressure from more than 30 family shareholders to sell Friedman Bag Co., against the wishes of company management, was threatening to destroy the value of the closely held Los Angeles company founded by three brothers in 1927.
The far-flung shareholders, only one of whom worked at the company, wanted to cash out their shares. Management, including two sons of the founders, was desperate to invest the money in equipment needed to bring the company into the 21st century. Company workers were still sewing burlap and mesh bags for the agricultural industry by hand. Printing presses were slow and inefficient. Morale and sales were suffering.
"It was like a tug of war," said Harvey Friedman, chief executive and son of one of the retired founders. As the debate intensified, rumors that the company was going out of business began to fly.
Friedman Bag didn't have the money to cover shareholder buyouts and new technology. The shareholders weren't interested in a note--a written promise to pay them in the future. And sale of the company's real estate wasn't an option because of the huge tax bill that would result, Friedman said.
For the first time in more than four decades, the company was forced to consider going outside for financing.
It's a classic dilemma for a family business. The conflicting demands on company funds of growth or expansion and shareholder buyouts or dissolutions can push the most debt-averse company to seek outside money, particularly if buyout funding isn't covered by insurance or some other previous arrangement. Perhaps it's the founder who wants to cash out, or an owner dies and there are estate problems. Or an owner without an heir interested in the business may want to sell the company to the employees through an employee stock ownership plan.
"Growth, liquidity, unexpected dissolutions that can disrupt the business are needs for financing," said Alfred E. Osbourne, director of the Price Center for Entrepreneurial Studies at UCLA.
A business typically has two options when it comes to outside money--taking on debt through a bank loan or selling a stake in the company to an equity investor.
Friedman Bag, like most family businesses, chose debt, unwilling to deal with additional shareholders and their demands. The company polled its industry contacts for potential lenders. After being debt-free for decades, it found itself being wooed by more than 20 banks. Friedman and his managers decided on Imperial Bank in Los Angeles for several reasons. They got a speedy response and a loan package that covered their needs: an equipment line of credit, a term loan to buy out the shareholders and an asset-based line of credit to pay for growth. The bank's enthusiasm for the company's prospects sealed the deal.
"When you borrow money, you want to feel like the bank is excited about your new venture and not that they are doing you a big favor," Friedman said.
All things being equal, he'd just as soon lend to a family business, said Imperial Bank Executive Vice President Duke Chenoweth, who grew up in a family with a business.
"A family will generally put everything they have on the line to uphold the integrity of that family business and the family name," he said. In addition to a potentially deeper level of commitment than an absentee owner or a group of professional managers, a successful family business often has a built-in successor, important for management continuity, Chenoweth said. And if worse comes to worse, often the retired founder can be relied upon for emergency guidance or deep pockets.
Bank debt isn't right for every family business, of course. A company has to be able to generate enough cash flow to repay the debt, which naturally limits how much money a company can borrow.
Although it's not as common for a family business, an outside equity investor can also provide needed cash. The downside is that most equity investors are institutional investors who typically expect a return on their investment within three to five years. That's not practical for many family businesses.
"It would be a mistake to say private equity has no place in family business, but it would only be under specific circumstances where the family is willing to provide a liquidity event," said Jourdi de Werd, a managing director and co-founder of investment bankers Greif & Co. of Los Angeles, one of several corporate sponsors of the Family Business Program at USC.
A family that is contemplating a transition to more institutional ownership or a founder that wants to take capital out of the business might turn to an outside equity investor, said de Werd, who also grew up in a family with a business.
Friedman offered several tips for family businesses thinking about outside financing.