Same same, but different: capital structures in single family offices compared with private equity firms

Researchers have long studied capital structures of different firm types and have sought to explain—among other things—the mix of equity and debt for a firm and what factors influence the underlying decision-making process (Gompers et al. 2016). However, given the multitude of factors influencing financial decisions (Myers 2001), our understanding of capital structure decisions in family entities remains incomplete.

The trade-off theory predicts an optimal capital structure (i.e., a target debt to equity ratio) based on the balance between the costs and benefits of using debt (Harris and Raviv 1991; Myers 1977; Stulz 1990). The foremost advantages of debt financing are the tax-deductibility of interest payments (called “tax shield”) and the potential avoidance of liquidity issues. However, a high level of debt also involves the costs of financial distress, a higher bankruptcy risk (Kraus and Litzenberger 1973), and the costs of the information asymmetries between shareholders and creditors (Jensen and Meckling 1976). Hence, the resulting optimal capital structure differs among firms, depending on the firm’s characteristics, available assets, and business models (Myers 1984).

In contrast with trade-off theory (which solely distinguishes between equity and debt), pecking-order theory (Myers 1984; Myers and Majluf 1984) assumes that there is no optimal capital structure. Specifically, decision-makers have the objective of minimizing the costs of the information asymmetries between internal and external agents because such costs (e.g., monitoring and transparency requirements) might result in less favorable debt conditions. Pecking-order theory thus postulates that in cases of information asymmetries, financing decisions are based on hierarchical preferences. Specifically, decision-makers will opt for internal financing and will only opt for the capital market if internal financing options are insufficient (Myers 1984).

While originally developed for publicly traded firms, an increasing number of scholars also apply the two theories in the context of private structures (Michaelas et al. 1999), for which the outcomes, however, seem to be more nuanced than for other types of firms. For example, scholars widely agree that PE firms primarily follow the trade-off theory (Gompers et al. 2016) and raise as much debt as they can (Axelson et al. 2013, Gompers et al. 2016). In contrast, some family firm financing researchers find that families follow a pecking-order hierarchy and prefer external debt over external equity when additional financing is sought (Blanco-Mazagatos et al. 2007; Poutziouris 2001), whereas other studies indicate a negative relation between family ownership and debt financing in both public and private family firms (Gallo and Vilaseca 1996; Mishra and McConaughy 1999). The latter is explained by the fear of bankruptcy and the aim to maintain control (Gallo and Vilaseca 1996; Mishra and McConaughy 1999). Although these studies highlight differences among business families regarding the willingness to use debt, they indicate a general preference for internal over external financing options and thus follow a hierarchical approach in line with pecking-order theory.

To explain the observed heterogeneity in family firm capital structures, several scholars emphasize the need for the integration of nontraditional theoretical approaches, such as incorporating behavioral aspects. For example, Hutchinson (1995) stresses that behavioral aspects mitigate the demand for financing in small owner-managed firms. Other scholars emphasize that risk aversion and owners’/managers’ individual goals affect debt financing (Barton and Matthews 1989; Romano et al. 2001). Given that behavior might serve as an explanation for why entrepreneurial families prefer certain capital structures, in the following, we analyze the interaction of the BAM and traditional capital structure theories to increase our understanding of financing decisions.

Financial decisions and risky decision-making can often be explained by the BAM (Wiseman and Gómez-Mejía 1998), which challenges the general assumption of static risk-taking preferences but suggests that decisions are based on problem framing and loss aversion (Cyert and March 1963; Wiseman and Gómez-Mejía 1998), which means that decisions are evaluated against potential gains and losses (Gómez-Mejía et al. 2010; Kahneman and Tversky 1979) and that the prevention of losses is considered more important than obtaining gains (Chrisman and Patel 2012). However, to date, findings on family firm decision-making processes with respect to their capital structure are mixed.

Concerning the level of debt, González et al. (2013), for instance, find that the need for financial growth without the loss of control leads to higher debt levels. Additionally, they find that older firms tend to raise more debt than younger firms, which they relate to the founders’ assumed high levels of risk aversion compared with that of their heirs (e.g., González et al. 2013; King and Santor 2008). Studies showing that family firms raise similar debt levels as nonfamily firms (e.g., Anderson and Reeb 2003) indicate that business-owning families do not adjust their capital structure decisions to reduce risk (Amore et al. 2011; Anderson and Reeb 2003). In contrast, studies finding a negative effect of family ownership on debt financing (e.g., Ampenberger et al. 2013; Mishra and McConaughy 1999), especially for family firms with a high market share within the respective industry (Gallo and Vilaseca, 1996), indicate a higher fear of bankruptcy (often associated with personal bankruptcy) and a stronger identification of the family with the firm.

Although the academic literature has, to date, yielded inconsistent findings with respect to the debt levels of family vs. nonfamily firms, most studies stress that business-owning families prefer internal over external financing options (e.g., Gallo and Vilaseca 1996; Reid et al. 1999) due to owners’/manager’s pursuit of noneconomic values and the fear of loss of control, thus producing their risk aversion (e.g., Barton and Matthews 1989; Romano et al. 2001). However, if internal financing options are insufficient, then business-owning families might first turn to debt before considering equity (e.g., Anderson and Reeb 2003; González et al. 2013), in line with pecking-order theory.

While extant research has primarily focused on the drivers of capital structure decisions within the family firm, the influence of entrepreneurial families on debt financing may be even more salient in financing decisions outside the family firm, such as in an SFO. SFO-owning families likely differ from business-owning families in their preferences for raising debt, although both types basically rely on an entrepreneurial family (Schickinger et al. 2020). In particular, these types of entities differ to a certain extent in terms of their governance structures (a united group of family owners vs. the SFO as an intermediary structure; Zellweger and Kammerlander 2015), portfolio of investments (original family firm vs. outside entrepreneurial investments; Bierl and Kammerlander 2019), entrepreneurial behavior across generations (the intention to pass on entrepreneurial investments to the next generation or not; Schickinger et al. 2020), or preferences regarding financial resources (debt vs. equity). With respect to the latter, SFOs are more likely to focus on internal financial resources to avoid external pressure, whereas family firms often require funding for technological enhancements or market extensions to remain competitive (e.g., Sirmon and Hitt 2003). Increasing our academic understanding of the debt preferences of SFOs seems crucial to gain a more holistic picture of entrepreneurial families’ external debt financing choices.

To further investigate families’ capital structure decisions outside the family firm, we follow recent calls of SFO scholars that stress the importance of comparing SFOs with other types of investors without a family background, such as PE firms (Block et al. 2019; Rottke and Thiele 2018). To do so, we shed light on the key benefits and costs that, according to capital structure theories (trade-off and pecking-order) (Myers 1977, 1984) as well as the BAM (Wiseman and Gómez-Mejía 1998), come with debt financing in the context of DEI investments: the benefit of deductible interest payments and the cost of financial distress (Kraus and Litzenberger 1973). With regard to the benefits of deductible interest payments, we assume that the interest tax shield is identical for both SFOs and PE firms, whereas regarding the costs of financial distress, the line of argument is linked first to diversification and, second, to bankruptcy consequences.

First, although SFOs are generally well diversified in terms of their overall portfolio (Rivo-López et al. 2017), they often suffer from an inadequately diversified allocation of DEI due to their large investments in single portfolio firms and their frequent aversion to external financing, corresponding with pecking-order theory. In contrast, as PE firms, which frequently following the trade-off theory, draw capital from multiple external investors, their assets under management in DEI are generally higher than those of an SFO (Block et al. 2019), which enables PE firms to better diversify regarding firm size or firm life cycle (Rottke and Thiele 2018). Second, bankruptcy consequences are more severe for SFO-owning families because of the family’s wealth concentration and their private benefits as prescribed by the BAM (Cyert and March 1963; Wiseman and Gómez-Mejía 1998). Thus, the BAM predicts that the cost of financial distress is higher for SFOs (similar to family firms) than for PE firms (similar to nonfamily firms) (c.f. López-Gracia and Sánchez-Andújar 2007). In sum, the risk associated with debt increases in less-diversified portfolios (such as for SFOs), and financial hardship is higher for loss-averse SFO-owning families. Hence, according to the BAM, we propose that SFOs are less likely to use higher debt levels than PE firms.

Moreover, since SFOs are entities that are funded with family equity, their investment decisions depend on the respective family but are typically independent of predefined targets (Bierl and Kammerlander 2019; Rottke and Thiele 2018). Therefore, SFOs benefit from the option of solely relying on internal financing (their first hierarchical preference with zero leverage; Myers 1984) when making DEIs. In contrast, PE firms generally require debt to meet predefined, often ambitious returns for investors (Dawson 2011). Thus, based on pecking-order theory and the BAM, we expect SFOs to be less likely to use the same or higher debt levels than PE firms because SFOs have the option of relying on internal financing (and thereby avoiding bankruptcy risk) instead of raising debt, whereas PE firms need to use debt to achieve predefined returns. In sum, we hypothesize the following:

While ownership structure may impact debt financing decisions, as just hypothesized, this relationship is likely further affected by three characteristics that are idiosyncratic to family investors (Gómez-Mejía et al. 2018). First, the overlap of ownership and management structures typically results in a sense of high psychological ownership towards the firm and a correspondingly increased need for control (e.g., Bacci et al. 2018; Pierce et al. 2001; Romano et al. 2001). Second, firms with a family background often span generations and are thus old and well established in their environment, which increases the intention to establish transgenerational control (e.g., González et al. 2013; Schulze et al. 2003; Zellweger et al. 2012a). Third, business families pursue noneconomic goals (e.g., Molly et al. 2019) related to SEW and thus seek to protect their SEW endowment (Gomez-Mejia et al. 2007). In the following, we analyze how these typical idiosyncrasies moderate the relationship between ownership structure and debt financing.

We test our hypotheses using a sample of German-speaking SFOs and PE firms because entrepreneurial families represent the backbone of the German, Austrian, and Swiss economies and have a long-standing tradition (De Massis et al. 2018). We performed multiple steps to identify study participants given the immense lack of transparency and the difficulty in obtaining reliable information on SFOs and PE firms (Amit et al. 2008; Cumming and Groh 2018). Specifically, in the context of SFOs, it is challenging to obtain access to study participants because SFOs are privately held, generally have no legal obligation to disclose information, and often minimize public appearances to maintain their confidential nature (Decker and Lange 2013). As such, previous SFO and PE studies generally rely on small sample sizes (Welsh et al. 2013, Michels et al. 2020). Moreover, we further constrained our study because we only included SFOs with a focus on DEI. Given that only a limited portion of all SFOs conduct DEI, we could only determine whether an SFO had experience with DEI during private discussions with representatives of SFOs.

The study included three phases of data collection. First, we identified possible SFO study participants and conducted semistructured interviews with family members or senior managers of SFOs. Second, we identified possible PE study participants and conducted interviews with PE managers. Third, we collected data from the Amadeus database, which includes ownership information for firms based in Europe.

We took several steps before and during the data collection process to minimize the risk of common method bias. First, given that our questionnaire items were primarily fact-based (Tourangeau et al. 2000), our variables are unlikely to be affected by such issues (Chang et al. 2010; Crampton and Wagner 1994). Second, our study variables were embedded in a comprehensive questionnaire on entrepreneurial behavior, activities, and organizational structures and did not reveal any potential, assumed relationships among constructs. It is thus unlikely that the interviewees adjusted their answers in line with expectations. Third, we assured strict confidentiality and thereby minimized the probability of socially desirable answers (Podsakoff et al. 2003).

Additionally, we conducted the Harman single factor test (Podsakoff and Organ 1986), a principal component factor analysis of all the study variables. The analysis revealed three factors with eigenvalues greater than one, with no single factor explaining the majority of variance. Moreover, we conducted a marker variable test to investigate correlations between the dependent variable (i.e., debt financing) and the marker variable (i.e., the importance of human capital in the target portfolio firm⁴), which are theoretically unrelated to and uncorrelated with the focal variables (Lindell and Whitney 2001). The significances of the correlations between the main and revised models were not substantially different (Van Doorn and Verhoef 2008). In sum, common method bias will unlikely distort the findings of our study (Podsakoff et al. 2003).

The survey was conducted in German. To ensure accuracy and maximum comprehensibility, we applied an iterative, two-way translation (Dickson et al. 2006) from English to German for established scales. Given that objective and public data on SFOs and PE firms are scarce (Amit et al. 2008; Cumming and Groh 2018), most measures (except for owner management) were self-reported. However, previous studies have shown that financial data, such as debt levels reported by executives, are typically reliable (Tan and Litschert 1994), especially when reported anonymously (Dillman 1978).

The descriptive statistics, including the means, standard deviations, correlation matrix, and variance inflation factors for all variables, are presented in Table 1. In the regression model, we used the natural logarithm of firm size to minimize skewness. For a better interpretation, we additionally included the raw values of firm size in the presented tables. Table 1 shows acceptable levels of correlation (i.e., below the threshold of .30) between independent and control variables (Hair et al. 2010). We also addressed issues of multicollinearity and examined the variance inflation factors. Specifically, with the highest variance inflation factor at 1.85 and the mean variance inflation factor at 1.28, the values are below the generally proposed threshold of 10 (Hair et al. 2010). These results indicate that multicollinearity is not an issue in our study. Moreover, as this study compares German-speaking SFOs to PE firms, we used t test analyses to compare characteristics and to gain a better understanding of the differences among the two sample groups. We found only few significant differences in debt financing, firm size, and SEWi. These findings are presented in Table 2.

In a first step, we checked whether our sample was representative of the total population of German-speaking SFO and PE firms. Overall, our SFO sample accounts for 30% of the entire (estimated) SFO universe in Germany (Bierl  and Kammerlander 2018), our PE sample accounts for approximately 36% of all small- and midcap PE firms in Germany (Listenchampion, 2020). We thus expect that this significant proportion of the overall population provides a representative picture. Moreover, putting this situation in a broader perspective within developed countries, we assume steady descriptive results within the PE universe because the investment concepts of PE firms are very similar internationally. In the context of SFOs, the results may vary because access to debt and cultural specifications (among others) may differ.

The sample consists of 104 firms: 50 SFOs (48.10%) and 54 PE firms (51.90%). The mean debt-to-equity ratio of all the study participants is 2.32 (s.d. = 1.04). The means of the debt-to-equity ratios of SFOs and PE firms show statistically significant differences (p = .000). Specifically, the mean debt-to-equity ratio of SFOs is 1.86, and the mean debt-to-equity ratio of PE firms is 2.74. Moreover, the average percentage of owners on the management board is 64.51% (s.d. = 41.23; 65.72% in SFOs vs. 63.39% in PE firms), and the average firm age is 17.38 years (s.d. = 11.21 years; 17.20 years for SFOs vs. 17.54 years for PE firms). The means of the SFOs and PE firms for these two item characteristics show no statistically significant differences. Last, the respondents rated the importance of SEW on average at 3.84 (s.d. = .55; based on a five-point Likert scale). In line with our theoretical reasoning, we find significant differences (p = .022) in the mean importance of SEW between SFOs (3.97) and PE firms (3.72). Further descriptive findings are highlighted in Table 1 and Table 2.

We calculated ordered logit models to test the direct and moderated effects of the binary independent variable type of investor on the ordinal dependent outcome debt financing. Table 3 presents the results of the analysis. Model 1 presents the findings of our baseline specification containing only control variables. Model 2 includes the independent variable type of investor and the moderator variables, testing for the direct effect on debt financing (H1). Model 3 adds the interaction between type of investor and owner management, firm age, and SEWi simultaneously to the former specification and allows testing for moderating effects (H2–4).

Model 1 shows that the natural logarithm of firm size is positively and significantly related to debt financing (ẞ = .626, p = .002). In contrast, the control variables club deal investments and current holdings are not significantly related to debt financing. Model 2 shows that the type of investor affects debt financing negatively and significantly (ẞ = − 1.966, p = .000). This result indicates that SFOs (coded as “1”) are less likely to raise high levels of debt when investing in DEI than PE firms (coded as “0”). Thus, we find empirical support for Hypothesis 1. The pseudo-R² value of .138 for model 2 indicates a good model fit.

In model 3, first, the interaction between the type of investor and owner management has a negative and significant effect on debt financing (ẞ = − .022, p = .037). This result indicates that owner management strengthens the negative relationship between SFOs and debt financing, in line with Hypothesis 2. Second, the interaction between type of investor and firm age is negatively and significantly associated with debt financing (ẞ = − .088, p = .028). Thus, firm age strengthens the negative relationship between SFOs and debt financing, in line with Hypothesis 3. Last, we find that the interaction effect of the type of investor and SEWi does not significantly affect debt financing, leading us to reject Hypothesis 4. The pseudo-R² value of .175 for model 3 indicates a good model fit.

Although prior research on capital structures suggests a substantial impact of ownership on financing decisions, its empirical evidence has, to date, still been fragmented and characterized by diverging results (e.g., Mishra and McConaughy 1999), for instance, regarding the level of debt of family-owned entities compared with other types of firms (González et al. 2013; Mishra and McConaughy 1999). Extant research on capital structure decisions within the family firm has found that entrepreneurial families generally consider three types of capital in hierarchical order: internal equity, external debt, and last, external equity (Myers 1984), which follows pecking-order theory (Gottardo and Moisello 2014).

By building on these findings, in this study, we aim to go one step beyond and investigate the financial decisions and debt preferences of entrepreneurial families outside the family firm, particularly in an SFO. SFOs constitute a fruitful context for debt discussions because this type of investment vehicle allows families to distinctly and freely choose whether to raise debt (independent of market challenges). However, to date, there is a lack of research on the capital structures of SFOs, as previous studies are primarily descriptive (e.g., Decker and Lange 2013, Rivo-López et al. 2017) or qualitatively analyze (e.g., Welsh et al. 2013) the investment behavior of SFOs but fail to investigate the drivers of capital structure decisions quantitatively. This research gap is surprising given that scholars stress the need for more research on SFOs (Welsh et al. 2013) due to their unique exposition at the intersection between family financial decisions and family ownership idiosyncrasies (Rivo-López et al. 2017; Wessel et al. 2014).

To investigate SFOs’ capital structure decisions, particularly their debt preferences and the influence of the unique aspects related to family ownership, we compared family-owned SFOs and PE firms. In a first step, we hypothesized and showed that SFOs follow pecking-order theory (Myers 1984; Myers and Majluf 1984) and thus raise lower levels of debt in the context of financing DEIs than PE firms, which frequently follow a trade-off approach with higher levels of debt. Moreover, in line with the BAM (Wiseman and Gómez-Mejía 1998), we argued for and empirically revealed that owner management and firm age strengthen these relationships, whereas surprisingly, the importance of SEW did not show a significant moderation effect. We propose that the significant moderation effects can be explained by increased levels of loss aversion (Ariely et al. 2005).

Our study contributes to academic research in at least the following two ways. First, we contribute to the literature on family-owned SFOs and their capital structure decisions (e.g., Bacci et al. 2018; Gottardo and Moisello, 2014; Koropp et al. 2013; Molly et al. 2019) by investigating debt preferences when making DEIs outside the family firm in comparison with PE firms. Our empirical findings thereby add to the literature by indicating that SFOs (compared with PE firms) are less likely to raise high levels of debt when financing DEIs than PE firms. Thus, SFOs tend to rely solely on internal financing and only raise debt when explicitly considered (independent of market challenges). The previous family firm literature has only considered family structures in which debt was potentially needed to be raised because of certain market challenges (e.g., need to grow) or in which raising external equity was the only option to remain competitive (e.g., Sirmon and Hitt 2003). Our results study a context (SFOs) in which business families can freely decide to assume debt. We show that SFOs, similar to family firms, follow pecking-order theory (Myers 1984; Myers and Majluf 1984), while PE firms follow the trade-off approach (Kraus and Litzenberger 1973). Hence, SFOs significantly differ from PE firms. SFOs as a unique unit of analysis thereby also add to the research on debt financing in general because they provide the unique opportunity to combine both perspectives of the owning family and the capital structure decisions within the investment (i.e., DEI) context.

Second, with our empirical study, we answer various calls to further investigate heterogeneity among SFO capital structures (Welsh et al. 2013) as a potential result of the idiosyncrasies stemming from the involvement of an entrepreneurial family (Block et al. 2018; Welsh et al. 2013; Zellweger et al. 2012b) by comparing them to PE firms without a family background (Rottke and Thiele 2018). Moreover, we analyze the moderating effects of owner management, firm age, and SEWi on the debt financing of SFOs. Our data support the importance of considering the moderating factors of family ownership by providing unique evidence that SFOs behave heterogeneously regarding varying degrees of owner management or firm age. In contrast, SEWi does not seem to affect the capital structure decisions of SFOs. Our descriptive results, with a mean of 3.969 for SFOs and a mean of 3.722 for PE, thereby challenge prior research stating that SEW is only linked to family structures (Gómez-Mejía, et al. 2007; Molly et al. 2019) and the existence of a family firm (Chirico et al. 2019) and indicate that nonfamily structures also regard noneconomic goals as important. A driver for the high rating of SEWi for PE firms might be the increasing importance of reputation among competitors and towards outside investors, employees, and potential sellers. Additionally, our data challenge the assumption that entrepreneurial families always consider noneconomic (Gómez-Mejía, et al. 2007; Molly et al. 2019) goals but suggest that differences regarding financing decisions between family and nonfamily structures are based on economic considerations.

In addition to those contributions to extant research, our study also holds various practical implications. We enable SFO-owning families and managers of PE firms to benchmark themselves in terms of the debt levels and idiosyncratic effects within the same peer group as well as with their respective counterparts. Our study thereby provides transparency and a more profound understanding of competitors and investors in the SFO/PE market and might enable owners and/or managers to adapt and rethink capital structure decisions. Moreover, our findings enable external stakeholders (e.g., nonowner managers, advisors, debt suppliers, or service providers) to better understand idiosyncratic factors that impact capital structure decisions. Last, we provide sellers of established firms with more insights into a currently opaque investor market (Amit et al. 2008; Cumming and Groh 2018). Sellers of established firms may use our findings to better assess the risk-taking behavior of potential acquirers to more confidently negotiate a selling process.

Similar to other empirical studies, our study has some limitations, many of which provide important avenues for future research. First, although a focus on German-speaking SFO-owning families and PE firms is reasonable due to the economic salience in this country and the comparison of entities with a similar legal and cultural background, our results may not be generalizable to other economic and/or cultural contexts. Second, our sample is constrained in size, which is common in the context of research on SFOs (Welsh et al. 2013) and PE firms (Michel et al. 2020) given the small overall population, the difficulties in obtaining highly confidential financial data, and the lack of transparency (Amit et al. 2008; Cumming and Groh 2018). To mitigate these concerns, replication studies in similar and different cultural settings are encouraged. Third, we measured the ordinal dependent variable debt financing at a certain point of time (i.e., the time of the interview), which further limits the generalizability of our results. Although we followed the suggested debt categorization by Schulze et al. (2003), empirical longitudinal studies would be helpful to better capture generational, temporal, and market differences in capital structure decisions within SFOs and PE firms.