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“We Only Do Good Deals” is Not An Investment Strategy – Part 1

There is something about platitudes that we all instinctively gravitate towards.  Because of their near ubiquity and embedded common sense, we often accept them quickly, at face value.  English Painter Sir Joshua Reynolds affirmed this when he observed, “There is no expedient to which a man will not go to avoid the real labor of thinking.”

This is true as well for the real difficulty of developing, articulating and executing on an investment strategy.  Far too often, family offices who are choosing to go down the path of direct investing are unable to articulate an investment strategy beyond that of “we only do good deals.”  This expression being the very embodiment of an investment platitude. 

Of course, you only want to do go deals, but how to go about doing so is far more complicated.  To further explain, today we are going to begin a multi-part series look at the difficulty of “only doing good deals.” 

Family Identity – Are you a builder of businesses vs. one business?

We will begin our series by asking the most core question before embarking on any strategy of doing additional deals.  Are you (personally or as family) a builder of a single business or a builder of multiple businesses?  There are many families who have built their family wealth through building multiple businesses – and they are among the most storied of business owning families.  Think the Pritzker’s of Chicago, the Bronfman’s of Canada, the Koch’s.  There are certainly others who have built sizable, multi-business enterprises, but they are the rarity.

That is not to say the families may not own other businesses.  Professors Zellweger, Nason and Nordqvist in their 2012 paper “From Longevity of Firms to Transgenerational Entrepreneurship of Families:  Introducing Family Entrepreneurial Orientation” present interesting survey data regarding the ownership of businesses by families.  

Their study finds that families on average control 3.4 business entities, but that one core business provides roughly 75% of the total revenues of the family business group.   The paper’s focus is on level’s of entrepreneurial activity within families and that the number of businesses controlled by the family is indicative of this entrepreneurial orientation.  Instead, I would argue that the most salient data point is that despite this entrepreneurial activity, the fact is that a single asset contributes the majority of the financial capital to the family business enterprise.  This heavily weighted contribution of a single asset speaks to the difficulty of building a highly successful, multi-asset business portfolio. 

Let’s place that reality in a bit of context. 

Winning the Business Lottery

Each year, per the Census Bureau, north of 3.5MM businesses form.  According to the U.S. Bureau of Labor Statistics, 20% of businesses fail in the first year alone.  65% within the first ten years, and only 25% make it to year 15.    These failure rates are consistent in the venture backed world as well – with nearly 80% plus failure rates over the life of the business.  In the family business arena, John Ward noted in his 1987 study that only 13% of family own firms survive to the third generation, and only 3% beyond that.

With all start-ups and specifically venture backed start-ups exhibiting similar failure rates, one clear conclusion is that  being adequately funded is a necessary but not sufficient for new venture success.   Finding product market fit and then building an enterprise that can grow and scale is incredibly difficult.  Families who have successfully built one successful company should recognize the heroic accomplishment of doing it once, as well as have a sober assessment of the odds of doing it again (once or multiple times).

This is why families who have built sizable businesses multiple times are such a rarity, and even in those circumstances, the question is whether or not the families were just lucky or if they have a unique skillset for doing so.

The Myth or Reality of Human Capital in Business Building?

A key part of this sober assessment must be on the actual role of the family in building its enterprise, and the potential transfer-ability of that knowledge base / acumen / industry relationships into additional ventures. 

As any parent well knows, the passage of time is quick to remove from mind the challenges that you face in child-rearing.  So too is the inherent story telling of family’s regarding their business.  Without caution, the family can easily forget or gloss over the existential crises that likely occurred in building the family business.  Moreover, similar to how studies show that nearly all drivers assess themselves as being above average in their driving ability – a mathematical impossibility, the family may not have a clear and sober assessment of its human capital in building the business. No doubt hard work went into the creation of any enterprise, but it can often times be difficult to recognize the role of luck.

As such, if the family contemplates investing in other business, there should be an unbiased and objective mechanism for clearly ascertaining the skills of the family and their transfer-ability to any new venture.  Skill gaps should be identified early and remedied through either education, or the thoughtful addition of non-family executives bringing the necessary skill sets.

Conclusion

We are beginning a multi-part series about the inherent challenges of ‘doing good deals,’ working to the conclusion that the family should go eyes-wide open into any efforts to diversify its business activities away from a core business.  Today, we outlined that most families build their financial capital through a single business, and while they may have other business assets, there is generally a core business that dominates the rest.  

Within this core business is embedded the reality of a ‘lightening strike’ or ‘lottery win’ that added the right dosage of luck to the family’s incredibly hard work to propel the business towards long-term success. As such, the family should consider its past success with a level of humble confidence. Finally, we concluded by considering the role of the ‘family’ itself in its success and whether or not the business acumen of the family is transferable to other business ventures.  While it may be, again wide-opened caution should rule the day. 

In Part 2, we will look at the second challenge of ‘doing good deals’ – the competition that exists in doing those same deals.

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