A recent article in Forbes magazine made the following points: stocks listed on U.S. stock exchanges have declined from 7400 to 3600 in the past 15 years; public companies earn less than half of business profits in the U.S. economy today; and the part of the business sector that is not listed outperforms that which is listed. Obviously, family businesses make up a substantial portion of the non-listed universe (and the publicly traded universe as well). These data speak once again to the size and importance of family business in the economy and the comparatively better results of private companies over public companies.
Last week was a great lesson in the consequences of emotional reactivity to business information. Monday’s news was gloomy – business conditions had eroded from earlier projections and the debt deal wasn’t enough. The Dow was in a free fall as investors ran for cover. The sun came up 24 hours later and investors realized that maybe they overreacted, and much of the losses were won back. Only to drop again, then roar back as a few key indicators seemed to back away from the story line of financial Armageddon.
Family enterprise shareholders are regularly exposed to information about their businesses, and not all of it is good news. When hearing bad news, it is natural to catastrophize and begin thinking of all the things that could go wrong, which nurtures further anxious thinking. Many a family CEO has received phone calls from fearful shareholders questioning management’s abilities at a time when management is usually working very hard to make the business work properly. Unless both caller and CEO are gifted communicators and can find common ground, it is not unusual to have the call end with the CEO frustrated and the shareholder finding little to ease the anxiety. There is a better way.
Families do well to work on building strong communication systems between the business and shareholders, and nurture trust through clear and agreed upon governance. This usually occurs in family ownership forums or family meetings, during which the family creates the rules for how governance will occur, and how information will be disseminated. Once this framework is in place, trust is built and strengthened over time as each group (Owners, Board, CEO, Family) lives up to its expectations with the others.
Trust and communication are necessary, but not sufficient to prevent reactivity among ownership groups. Also needed is a deep sense of long-term commitment towards achieving ownership’s vision. Securing long-term commitment requires that shareholders be educated about the business, the opportunities it offers to owners, and how it will achieve the owner’s objectives. For many enterprising families, shareholders are educated regularly (often starting at an early age) about the long-terms benefits of family business ownership. This education is crucial in helping shareholders appreciate and value the businesses they own, and to deepen their sense of long-term commitment to the business. Then, when difficult business situations arise, shareholders provide stability to the enterprise rather than chaos.
As for the stock market, one wonders what would have happened if investors all had a 10, 20 or 30 year investment horizon, rather than being driven by the news of the day. It probably would have been a pretty bland week.
The family of Wal-Mart founder Sam Walton continue to be a powerful force in that business. Son Robson Walton continues as board chairman of the $190,000,000,000 annual sales company. When Sam Walton died nearly 20 years ago, the family retained about 38% ownership of the company. Since 2003, the company has used spare cash for a series of significant stock buybacks. Family shareholders continue to hold their positions which public shareholders have opted for the money. As a result, the family’s holdings have grown to 49%. Recently, a new $15 billion buyback was announced. At current share prices, assuming the family neither sells nor buys additional shares and that the offer is fully subscribed, the family’s share will climb to 53%.
When a family owns a majority of a listed company’s shares, New York Stock Exchange rules no longer require that the majority of the board be independent. Some investors and pundits are complaining that the family will in effect be saying “trust us,” preferring a larger dividend rather than making funds available to repurchase shares. Of course, those who are unhappy with the situation can be among those who accept the offer.
In growing the largest company in the world (barring fluctuations in oil prices that impact energy company revenues), the Waltons have shown themselves to be outstanding stewards. Investing along side of them have made lots of folks lots of money. Betting on this family company’s success has given investors a ride from an Arkansas variety store, to the biggest business (and the biggest family business) there is.
Many successful family businesses have made the decision to become publicly traded while still maintaining a controlling interest within the founding family. Since family controlled companies represent approximately one-third of both the Fortune 500 and the S&P 500, it is logical to conclude that funding from the public markets is a useful strategy for some family firms. In fact, some of the most famous family business names, such as Ford and Nordstrom, have taken this path.
Initial public offerings (IPOs) have been used successfully to fund growth and provide liquidity in conjunction with ownership structures that provide for control to be maintained in the family. While the current recession significantly reduced the appetite for IPOs in most markets, as the economy improves so does the expectation that IPOs will once again become popular. However, before a family business decides to trade any portion of its shares in the public markets there are several important issues to consider.
Of course, the help and advice of excellent attorneys, accountants and investment bankers is critical to any successful offering. Yet even before engaging experts to take their company through an IPO process, business owning families need to have open and honest discussions regarding how even the smallest portion of stock in public markets can drastically change the way they do business. Here are some issues to consider:
- When your business becomes a publicly traded company it will be subject to a wide range of regulations, reporting requirements, and scrutiny that you and your management team may not be familiar with or comfortable in performing. Even with structures in place to preserve family ownership voting, the responsibility to meet SEC and other regulatory requirements can be onerous for many. In a very real sense it ceases to be your company, your capital and your decisions, even when it represents the combined wealth of your family. While perhaps a dramatic example, it has been argued that some of the business practices that led to fraud convictions for members of the Rigas family (Adelphia Communications) would not have been illegal if the stock had not been publicly traded.
- Those who buy your stock may have very different interests from you and your family. Today’s public markets are largely driven by traders not investors and they do not share the “patient capital” perspective that has traditionally represented the strength of family business. Their desire for timely returns on investment can represent a major conflict with the long-term planning and next generation focus of family owners. Under existing legislation, an owner of as little as 3 to 5 percent of a public company has significant rights that impact corporate governance. Both Barnes & Noble and the New York Times have faced challenges from these types of conflicts of interest, at considerable costs in both money and the time of leadership.
- In addition, the rules keep changing for public companies. In our post Enron/Lehman Bros. world the costs of being a public company have increased significantly. Smaller firms that once found IPOs a great source of capital now must carefully consider the “carrying costs” of public filings and the professional services needed to meet these requirements.
The very nature of public markets drives decisions that have short-term pay-offs. While good corporate governance theory maintains the importance of long-range results, efforts to incentivize, regulate and monitor such decisions have met with mixed results at best. Once a family business becomes publicly traded it may find that the very values that made it successful are under attack.