Financial constraints in family firms and the role of venture capital

Based on the natural reluctance of family-controlled firms (FCFs) to accept external shareholders, in this paper we analyze whether investment sensitivity to internally generated cash flow is a driver of venture capital (VC) participation in those firms. We argue that FCFs are more likely to accept external investors when they are subject to serious financial constraints. We also aim to ascertain to what extent VC involvement contributes to reducing the dependency between investments and internal cash flow. We focus on a representative sample of Spanish privately held FCFs that received the initial VC investment between 1997 and 2006, and compare the investment-cash flow sensitivity of VC-backed FCFs with that of non VC-backed FCFs. We find that FCFs that received VC were more financially constrained than other similar non VC-backed FCFs before receiving VC. This finding is especially true in first generation FCFs, thus providing additional evidence on the reluctance of FCFs to accept external shareholders. We also find that VC-backed FCFs, in particular first generation ones, significantly reduce the sensitivity of investments to cash flow after the initial VC round.