Adam Knight is a freelance financial journalist specialising in family business.
The prospect of an infusion of cash can be tantalising for family firms considering a share float. But are families willing to shoulder the regulatory scrutiny that follows an IPO? Adam Knight reports
The decision to take a firm public by floating it on the stock market is a difficult one at the best of times. It is typically based around a finely-balanced assessment of whether the extra opportunities that an initial public offering (IPO) offers will be undercut by the diminished control of the firm that will result. This choice becomes even more momentous in the case of a family business. Many observers believe that the insatiable appetite of the public markets to make short-term profits will dissolve the established culture of a family firm, and that an IPO may even lead to the family losing control of the enterprise in the long term.
The main driver in favour of going public is the desire for extra cash flow. By selling shares in the public equity markets, a family firm can in theory raise the funds required for the purchase of capital and marketable stock very quickly, and thereby enable the swift growth of the business. As well as this infusion of cash from the shareholders, banks may be far more willing to lend substantial amounts of money to a public company than to a relatively unregulated private concern. The increased financial clout provided by an IPO can make it significantly easier for a family firm to get to the negotiating table to discuss acquisitions.
An IPO has indeed proved a successful move for some family-owned firms – families control a large proportion of blue-chip companies, including Ford, Anheuser-Busch, Heineken and BMW. A UBS report of October 2003 found that French family enterprises had outperformed France's CAC40 index for a decade, and that family firms such as L'Oreal and Carrefour had benefited from long-term strategic thinking, limited diversification and strong organic growth. Investors are often highly attracted to family businesses, says Francois deVisscher, President of deVisscher & Co. "Family companies traditionally have low debt, are very conservatively managed and take a long-term view – all very attractive qualities to investors, especially after the boom-and-bust years of technology stocks," he notes.
An increase in available capital is not the only advantage to be closely associated with the passage from a private family firm to a public one. The genetic method of manager selection may not lead to the correct choice of candidate for the senior positions in the company, and in these cases the introduction of professional managers may well reverse the fortunes of a failing company. More fundamentally, the conversion of a private company to a public concern is often the only way of allowing owners of non-voting stock to convert their assets into cash. In this way it can provide a partial exit strategy, says Grant Gordon, director of the Institute for Family Business. "An IPO can permit one branch of the family to sell up and cash in, while allowing others in the family to retain their stake in the business."
This suggests that going public can often be equivalent to greed or a wish to break entirely with the family business. Moreover, the introduction of outside managers may fatally dilute the influence of the founding family, especially if the family comes to view the ancestral business as merely another asset in its portfolio. This loss of influence is often quoted by family firms as the prime reason for their resistance to going ahead with an IPO. If the family is determined to keep the business in the control of a small coterie of insiders, then there is a high potential for disaster when going public. While a familial business typically consists of a simple structure with the patriarch at its head, a public offering will instantly transform and complicate this model.
Going public means the owners of a family business instantly have obligations to their new shareholders, to add to the obligations already held towards employees, customers, suppliers and communities. Moreover, the shareholders can impose significant pressure upon the company to perform – and to perform immediately, not at some unspecified point in the future.
There may be little, if any, opportunity to carry out the kind of expansion abroad that the family-owned processing firm Cargill, for example, enjoyed in the late 1990s, and enjoyed precisely because its management did not have to defend its strategy to outside investors and securities analysts. Cargill was able to sustain seven years of losses in India, weathering anti-Western protests in the process, before finally turning a profit.
To a large extent the ability that private firms have to carry out long-term strategies is consigned to history, as the stock price of the company becomes of overwhelming performance to a public family firm. Instead of the 'patient capital' of the private business, the newly public company faces incessant calls for regular and increasing earnings. If the firm fails to meet its stated earnings and performance targets, then the owners can be assured that there will be lawyers at the ready to make sure that such indiscretions do not go unpunished.
Such pressures have affected the performance of even markedly successful IPOs such as California's care insurer Molina Healthcare. In this case, the pressure to appease quarterly earnings expectations exacerbated the already difficult task of ensuring that members received the care they need. As a result, surveys in both 2000 and 2002 by the National Committee for Quality Assurance, a non-profit group that measures the quality of managed care programmes, found Molina to be lagging behind in key health indicators.
It is simply not credible that a public firm could target long-term value enhancement at the expense of short-term profits, and this is likely to be an unhealthy situation for any family firm to find itself in. When a family company goes public, decisions cannot be made in response to changes in the business environment with the kind of alacrity that can be made by a powerful patriarchal figure operating at the head of a rigid company bureaucracy, as is found in many family firms.
The latent wrath of shareholders will not constitute the only challenge to family control in the event of an IPO. Quite the opposite. A board of directors will function as the premier stratum of the company, and investor relations, legal relations, securities commission relations and personnel departments will all have to follow swiftly. As in the case of Bacardi, the prospect of the founding family losing control to this extent can drive divisions between family members. Opponents of a possible IPO at Bacardi also fear that the hefty dividends paid to shareholders will be threatened. It is possible, however, to incorporate the positive aspects of outside influence into a family firm in a more subtle way, as has been shown at the New York Times, where the chairman and publisher of the flagship paper is a family member, but the CEO is not.
Over and above the range of conflicting interests in a family firm gone public, there is an increased degree of regulatory scrutiny to take into account after an IPO. In the US, for example, public companies must disclose profits and losses each quarter to the Securities and Exchange Commission. Executive salaries also provoke a great deal more interest in the world of public companies than they do in the world of private firms.
Francois deVisscher explains that public family businesses often become stuck in an environment of regulatory scrutiny to which they are unaccustomed. "Regulations on board governance, disclosure of salaries and so forth, can be difficult to comply with for a family unused to such strictures." The degree of scrutiny has become considerably greater in the aftermath of the Sarbanes-Oxley Act of 2002. Designed to avert the risk of another accounting scandal on the scale of Enron, this law established tight controls over company finances, and the perks once given to corporations' directors and officers are gradually becoming impossible to maintain under this new degree of regulatory watchfulness.
The loss of control incurred by a foray into the public sphere can threaten the very lifeblood of a family business. The risk of a takeover becomes greater than ever before, with the additional nightmare that any new owner will simply 'strip' the company of any assets that (s)he does not consider worthwhile, rapidly eroding the character of the business that has been established over decades. This outcome would pain so many family business owners who tend to be governed not solely by profits but by a rich vein of tradition. The incremental utility to the owner of an additional dollar may be negative if the non-economic costs of procuring it (such as demands on free time, family life and community interests) prove too high.
Even the basic assumption that going public will automatically guarantee a family company a significant increase in publicity is unfounded, points out deVisscher. "Realistically, in today's market of high growth technology companies, a traditional family business may attract very little attention from market analysts and bank analysts. Subsequently, its stocks may experience low liquidity due to very low levels of trading."
Delisting – not an easy route
The glut of difficulties that may afflict a family firm upon going public has led many currently listed family firms to think about delisting, says deVisscher. "The presence of strict corporate governance regulations and the lack of liquidity in their stocks lead the companies to feel that they will be better placed back in the private sector," he explains. "However, the process of becoming a private company is practically irreversible for many family firms. Should the firm wish to return to being private, then it runs the severe risk of being outbid by other entities in the sale, as the company's new board of directors is of course obliged to entertain all bids."
The process of delisting may indeed be extremely difficult, as Tang Wee Sung, chief executive of the Singapore retail empire CK Tang, found out in late 2003 upon submitting an offer to take the company back into family hands less than a decade after it had listed. He cited a deteriorating retail environment in Singapore and the economic ineffectiveness of remaining on the Singapore Exchange as reasons for the proposal. Shortly afterwards, the company's shareholders voted to reject a return to the private sector, as many felt that the offer Sung made undervalued the company.
It thus seems that family firms would be ill-advised to even consider an IPO without both a meticulous degree of research into every aspect of the operation, and a thorough consideration of the other options that are available to them in the quest to raise capital. Grant Gordon holds that going public should only be considered in specific cases. "Family businesses tend to feel at ease with private ownership, which allows the family to retain independence and control. On the other hand, the IPO market may be more attractive for a family firm with a big growth agenda. If the owners are prepared to see themselves diluted in order to open the opportunity for accelerating growth, then an IPO may potentially be a good path to follow."