Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
Families and businesses arguably have a lot in common: it is worth investing much time in understanding the intricacies of both and each will have its natural ups and downs. Tolstoy’s famous opening line to his novel Anna Karenina, “happy families are alike; every unhappy family is unhappy in its own way,” seems highly appropriate not just for familial relations but also in the context of the world of commerce, just substitute the word ‘family’ for that of ‘business.’ Against this background, it is intriguing to consider then the merits or otherwise of family-owned businesses. Definitions vary but are generally considered to constitute those listed companies where the founding family continues to exert notable control via meaningful equity ownership (typically at least 20%) and/or day-to-day management.
Both our conclusions and those of the various academic studies we have surveyed suggest that shareholder returns are generally superior in those businesses where family is involved rather than the inverse. This is perhaps contrary to the common perception that a broad shareholder base combined with professional managers drive businesses with a commercial aggressiveness focused on maximising shareholder returns that may be absent in the case of seemingly less competitive family operations. However, it is these latter businesses that will likely be in a position to assume a much longer-term vision for their organisation, one that is often focused on structural development over career progression.
The reality is that nearly all firms start out as family businesses. Put another way, the typical path followed is one of entrepreneurial energy and vision, often from humble beginnings, that – over time – may grow into a major economic force. This is the case not only in developed but also in emerging markets and examples abound, such as Wal-Mart and Inditex in the former to América Móvil and Orascom Construction in the latter. Such is the prevalence of family influence that some studies suggest that as much as 30% of America’s GDP (and more than 20% of its workforce) are constituted by family-owned/-controlled businesses, while in France and Germany, some 40% of these countries’ 250 largest enterprises can be considered as family businesses.
Even if there is no formal consensus on how precisely to define a family business, the reasons for their abundance and enduring success seem clear. Where family businesses principally differ from those where there is an absence of family influence is that in the former, there is an explicit focus on long-term value creation. Since the family’s welfare is closely tied to firm performance, there are limited incentives to avoid risking the family’s wealth and control of that business. In other words, company and shareholder interests become significantly aligned, creating a culture, typically with high levels of dedication. Indeed, the tenure of Chief Executives and other senior management at family business is often double that (over fourteen years rather than less than seven) in those companies where family influence is absent.
As a result, decision-making can frequently assume a more strategic nature, especially if supported by the financial commitment of the controlling family. Consider the example of News Corporation, who lost money in its satellite television venture in the UK for many years only for BskyB now to be the dominant pay-television provider in the country, or that of Lindt, who suffered six years of losses expanding into the American market, but has since reached and subsequently consolidated its position as the country’s leading premium chocolatier. Neither of these businesses would necessarily have been permitted by their external shareholders to persist (think of Tesco recently exiting the US grocery market), yet the long-term benefits have been indubitable.
Such companies can often continue with selective loss-making expansion since their balance sheets have the tendency to be more robust. A family business may likely be more focused on tax minimisation rather than profit maximisation per se. Conservative accounting can result in reduced tax bills rather than a tendency to seek to inflate earnings. A more prudent approach in accounting for depreciation, provisioning and research & development costs can also result in superior free cashflow generation, again conducive to longer-term investing. Inherent conservatism also often implies that family businesses tend not only to have less significant levels of financial leverage but also lower debt costs than do their corporate peers. One study (by McKinsey) estimates the average yield spread on corporate bonds to be some 25 basis points lower for family-owned business relative to their corporate counterparts in a study of US-listed industrials.
When it comes to deal-making, the combination of longer-term vision and enhanced financial flexibility is also appealing. In other words, M&A tends to be focused around strategic fulfilment rather than hubristic top-of-the-market acquisitions, but the great benefit also lies in families’ abilities often to act rapidly, with the decision-making structure being simpler than having to resort to external investors. In their research, McKinsey highlight that family-influenced businesses typically undertake smaller, but more value-enhancing (as defined by changes in market capitalisation) deals than do their shareholder-controlled peers.
Despite the potentially persuasive logic attached to the case for the family-controlled business, there are constraints to the argument too. The charge of nepotism is often hard to avoid, with families seeking to restrict top management positions to their own members (or favoured associates) rather than approaching more competent or qualified outsiders. Furthermore, when firm profits are redistributed through excess compensation to these members, this can adversely impact not only staff morale but consequently productivity too. The interests of a family firm – unsurprisingly – may not always be consistent with those of external investors. Family members may also not be aware of their own limitations and their proprietorship may hence make it hard for others to highlight this.
It is for this reason that some argue that the cost of capital for family firms should be higher since both debt and equity holders may conceivably demand some form of premium in exchange for allowing the family to exercise control. This control can often result in decisions that impact growth or returns (if, for example, a business were run with a high level of dividend cover) and high levels of risk aversion may restrict the investment necessary to perpetuate competitive advantage, or potentially help diversify a family’s wealth.
Nonetheless, the evidence is compelling in favour of the case for some family influence over none. Not only do family businesses tend to grow faster and with increased profitability, but also, shareholder returns are often superior. This contention applies across both different geographies and industries. One study, by Jim Lee in Family Business Review assesses data from US businesses over the ten-year period to 2002. Family-firms (with ownership in excess of 20%) averaged 14% revenue growth and a 10% net profit margin during this decade compared to figures of 9% and 8% respectively for non-family businesses. Moreover, such a performance was achieved with higher levels of capital expenditure (capex-to-sales averaging 3.6% versus 2.6%), supporting the earlier contention of investing for the long-term.
Both Lee in his study and Anderson and Reeb in their detailed works on the topic highlight that over most periods of the 1990s and early 2000s, shareholder returns from family businesses exceeded those of their listed counterparts. Separately, in a study conducted SYZ & Co Asset Management, an analysis of Europe’s largest companies demonstrates that family-businesses (again with a minimum 20% ownership threshold) outperformed their non-family peers by at least 20 percentage points over a three-, five- and ten-year period through to April 2012. Further supportive evidence is provided in McKinsey’s analysis which surveys businesses on both sides of the Atlantic during the years 2007-2009 inclusive, a period associated with the credit crisis and the collapse of Lehman Brothers, and so one of maximum stress. Although their threshold is set lower (at 10%), family businesses in the S&P 500 and the MSCI Europe indices delivered returns of at least 200 basis points in excess of their counterparts. This trend played out across all major industry sectors with the exception of healthcare and financial services.
It seems, therefore, that a compelling case can be made for investing in businesses where there is a controlling and hence aligned influence from a founding family. As ever, there are limitations to this argument and exceptions to the rule, but the logic of sharing in, and persisting with, a long-term strategy seems clear. Indeed, the approach taken with the Helicon Fund, Heptagon Capital’s global equity hedge fund, is to seek to invest in such businesses where the opportunity arises. Current examples include Duerr, a leading robotics manufacturer (which is 30% held by the Duerr family) and CA Technologies, a dominant provider of IT software (where descendants of co-founder William Haefner own 27%). Other businesses where family influence continues to play a significant role (and in which Helicon has been involved) include US house builder DR Horton, Paddy Power (the online gaming business), and Austrian conglomerate, Andrtiz. Annualised returns from all these companies have comfortably exceeded their market benchmarks over most recent time periods.
Alexander Gunz, Fund Manager
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