Many well-established family agribusinesses find ways to generate new streams of income independent of the core business. Despite the longevity or success of the family business, the inherent risk is typically tied to the legacy business – which also happens to be where most of the family’s wealth resides.
What if there is a catastrophic business interruption? What if the supply shuts down? What if new technology or global competitors upend a once-defensible position? Your family may very well run a tight ship, but there are many real-world possibilities for disruption that are simply beyond anyone’s control.
This is a common conversation among successful business families, especially from those who are thinking several generations ahead. There are many benefits to diversify a legacy business and providing alternative streams of cash flow. Risk management is typically the driving force, but there are other reasons too: preservation of long-term wealth, offsetting a cyclical industry, extending the enterprising legacy of the family, capitalizing on the family’s unique ability to innovate.
Privately held firms actually have an advantage in innovation because of their long-term perspective on capital efficiency, which allows for the “patient capital” attitude of owners to tolerate longer return cycles. Public companies, on the other hand, are pressured by short-term investors to focus on projects that maximize quick returns while demanding high hurdle rates.
If family businesses have such an advantage in long-term investing, why do we not see more active diversification playing out? What is holding back families from capitalizing on their own success? For many, it is simply a lack of expertise and direction in getting started. Looming questions arise: How do we evaluate industries or businesses we have no experience of? What kind of return expectations should we have? How much capital should we allocate?
The answers require some level of investment strategy, process, and accountability, which most family businesses simply haven’t developed because, well, they’re far too busy running their existing business. While the core business may be firing on all cylinders, the risk of venturing into new territory can appear greater than the risk of sticking to what they know, which has plenty of its own challenges to deal with.
The fact is, diversifying into new business ventures is fraught with peril. Therefore, family leadership must have a clear, compelling, and objective framework to ensure they are making good long-term decisions in the best interests of their current and future shareholders. Some families bypass this complication by parking their non-core investments in a third-party family office or private equity fund, leaving it to experts to manage their choices.
Many families, however, are uncomfortable with the passive nature of this option, preferring hands-on control, security, and sense of ownership over their new endeavours. All the more reason to take a systematic approach to ensure you get it right.
Diversifying your family business is certainly not any easy task, but it can be successfully accomplished if the following steps are applied.
1. Establish a clear and compelling vision for diversifying the business
Does your family vision statement tie the business to a single industry, or leave it open to grow from various sources? Despite your emotional attachment to the family business, it is nothing more than an asset representing a source of income and value creation. When families threat their business this way, they are more likely to acknowledge there may come a day when competitive pressures or capital requirements dictate the asset could create more value if it were liquidated and redeployed into higher-return opportunities.
This may sound blasphemous to certain family members, but when you stop and think about it, your family business legacy is likely to be more about growing wealth than clinging to a specific company or industry, especially if it is struggling to maintain relevance, or is losing value.
Articulating a clear statement of long-term intent cements your family’s commitment to enterprising beyond your core business, even if you are not sure what it might look like one or two generations from now. By raising the concepts of “diversified enterprises” as a purposeful direction for the family business, you also gain enthusiasm and buy-in from shareholders who will now publicly stand behind it, even expect it. Something powerful happens by agreeing on a future aspiration, writing it down and then providing frequent exposure to that message. You will eventually make it happen.
2. Set the strategic framework and criteria
Once a vision is established, the next step is to fill in details around strategy, which informs the type of industries and approaches you will take toward diversification. Start by casting a wide net around your playing field. What are you good at? What assets are currently underleveraged? What core competencies might be transferable to other markets or customers? This process taps into your unique capabilities to generate new, profitable sources of growth.
Next, layer in a filter of risk correlation. For example, would you prefer to focus on synergistic businesses, or countercyclical ones? Will you consider businesses related to your core enterprise, or do you want completely independent industries? An agricultural business historically depends on one product driven by commodity markets decided to venture into alternative commodities that were historically uncorrelated to its core product. You could also go horizontally forward or backward in your supply chain, but generally that only ties the risk further into your existing industry. Obviously, the less correlated an industry is with your core business, the more you are truly diversifying risk. Additional criteria to consider should include expected returns, industry growth rate, build versus buy, geographic limitations, and capital constraints.
3. Appoint a dedicated leader reporting directly to the CEO
Many diversification attempts either sputter out or produce spotty results because they lack dedicated, focused, accountable leadership to see the mission through. A diversification initiative cannot be approached as a part-time effort with a “let’s see how it goes” attitude.
The pitfalls of approaching diversification as a side project of current management are two-fold: Either the core business sucks management back in, leaving insufficient energy for the diversification initiatives; or the shiny new diversification projects become a distraction, drawing management’s attention away from the core enterprise.
Putting an objective leader in place can allow the business to cut through emotionally-driven decision making – a weakness that family businesses are prone to that often leads to a hodgepodge of starts and stops that may or may not be consistent with the strategy.
Once your investment criteria have been agreed upon, a designated leader operating separately from the core business can provide objective analysis of new opportunities and ensure that the family is accountable for achieving outcomes rather than dabbling. If you are serious about it, put a competent individual in charge, and then structure the new initiatives to operate separate and apart from the core business.
4. Apply a process to narrow down the best choices
Now that a strategy and criteria have been set, a process is needed to evaluate new opportunities. All ideas should be considered from a variety of sources, as if they are being thrown into a large funnel, except now there is a screening methodology for evaluating the strength of each proposition. The more aligned with strategic criteria, the further down the funnel the business idea will go. There should be just a few ideas coming out of the other side.
Despite the straightforward nature of this process, it is also where the family dynamics can get in the way, requiring management to remain disciplined. During this phase, one should expend enough attention to validate a fit with criteria, but no more than a first-pass level. An internal review board is helpful to vet ideas that make it through to more advanced stages, forcing justification and validation of the most promising proposals.
5. Develop the best ideas into a full-scale business plan
Here is where the viability of the business investment can be fully validated in great detail. This is no time for shortcuts or reliance on anecdotal information. Spend the time and energy necessary to develop a robust, data-heavy business plan with compelling market and financial justification, as if it were being pitched to an outside investment group. The business plan should cover typical components such as marketplace feedback. Industry growth rates, prospective customers, competitive landscape and a financial pro forma.
Ultimately, the business plan should clearly depict its unique strategic differentiator – Why will you win? What makes it a compelling investment?
Finally, get outside feedback from a third-party expert in the industry who can provide an unbiased perspective on your plan’s integrity and a critical view on its probability of success. A designated devil’s advocate can provide a reality check on your assumptions around operations, market, customer, pricing, and competitors. Even the most promising ventures will present challenges, so make sure you understand the minefields that will be faced.
6. Provide visibility and accountability
Once the new business plan has been vetted, critiqued, and approved, now it is time to take the leap and launch. The business plan should provide a set of milestones for tracking progress, which also becomes an accountability mechanism to ensure appropriate oversight and course correction when necessary.
Be prepared to evolve and iterate. Admit what you don’t know and bring in expertise to help operationalize when necessary. Diversification can be a risky proposition, but given the right commitment, process, and discipline, it can de-risk your business in the best interest of current and future shareholders.
Trevor Dickinson is the CEO of Family Legacies, a family business consulting company. For more information visit www.family-legacies.com.