Many families have built their wealth over time based on owning a particular company. With the success of this company the fortunes of the owning family have also grown. While this evolutionary path certainly represents a way for a family to accumulate wealth, there may, however, also be potential problems. The major one would be that the owning family might become perhaps too heavily exposed to the firm’s ups and downs. If the firm might run into difficult times, for instance, then also would the wealth of the owning family diminish.
Many families have been facing this dilemma of being over-dependent of the firm they own. For some families, the “solution” to this dilemma might be that their firm is sold, or at least their ownership share in the firm might be reduced, for so to make use of the proceeds to build a more diversified portfolio of investments. This means that “all eggs are no longer in one basket”, i.e. that the clustered investment risk that the family is exposed to would be reduced.
But, how might such a transition from company-based focus to a diversified portfolio of investments take place? We shall discuss this topic here, and then elaborate some more on why this process might be desirable. But, there might be counter-arguments too, and we shall discuss some of these in the final part of this paper.
The Process
It is of course of key pre-requisite that a suitable buyer for the firm can be found, and that the price is O.K. We shall not have to discuss this further here; rather, we shall raise some other issues that typically might come up during a sales process.
Resistance to a sale from the employees. For employees, a sale might represent a source of uncertainty, which might even impact their jobs. So, to ameliorate at least some of this resistance, it may be useful to incentivize the top management and employees to conclude the transaction.
Payment in cash. It should be kept in mind that the main purpose of a sale would be to enable the build-up of a more diversified portfolio. Hence, it is important that the firm would be sold for cash, and not for shares, nor based on some sort of earn-out scheme. In this way, the risk for the selling family would also be more manageable.
Criticism. Stakeholders and others in one’s network might typically not appreciate such far-sweeping changes as a sale would mean. Critical voices are typical. The sellers should be prepared for this, and be ready to accept that others might describe them as incompetent, or even as idiots.
Discipline. With a considerable amount of cash in hand, it may be tempting to rush into new investments. Here, several typical mistakes that I have discussed in another note (“My Five Biggest Investments Mistakes”) should be avoided. It is key to avoid suboptimal decisions due to “money burning in one’s pocket”.
So, why sell the family company?
In my opinion, there are at least three major reasons to sell the family firm, now to be discussed. Some aspects of what is to come have been touched upon already, but the arguments below are more full-focused.
A too large share of one’s assets may be tied up in one asset, the family-owned firm. And, many such firms would need the funds that it generates to be plowed back into the firm, for its own expansion and development. Often, therefore, the owning family might be quite strapped for cash. And, there might be quite heavy taxes to be paid by the family members as a fraction of the value of the firm. While many countries have abandoned such wealth tax, it is still in effect in some countries, such as in Norway. In general, the cash requirements of many firms, as they are growing, may be such that private family owners may simply not be able to come up with the additional capital needed. As a result, the family company may have to go public or be sold. For some family owned companies, however, where relatively large dividend payouts may be sustained, there might be an opportunity for the owners to diversify into other areas, i.e. to be able to develop a diversified portfolio while still maintaining the ownership of the family’s firm. This, however, is not the most common situation.
Enjoy the “power” of diversification. A diversified portfolio shall typically be much more liquid than what might be the case when the bulk of one’s values are tied up in a firm. Thus, one might be in a better position to enter new existing growth prospects, i.e. to be much more flexible and opportunistic. And, also one might relatively easily be able to exit from less attractive businesses. It would be easier to “cut the losses”.
The family’s company may be exposed to critical success factors that might be largely outside the owning family’s control. Examples of this might be, say, ship-owning, where the uncontrollable freight-rate movements may significantly impact a firm’s value; tobacco companies, where uncontrollable legislations might adversely impact cigarette smoking; or cement manufacturing, where the heavy CO2 emission may represent further adverse environmental exposure, just to mention a few. The bottom line here is that non-controllable factors might significantly impact the value of a family-owned firm.
So, why keep the family firm?
But, there are of course also strong reasons for keeping the family’s firm. Let me mention these here:
Family-owned firms benefit from the commitment of the family members involved. This very commitment and experience, often stemming from generations of involvement, often leads to stronger and more robust firms. Furthermore, the family members themselves may also attach a high personal value to their involvement. They might even deem that being involved may be worth more than security or higher monetary reward. A sale might entail loss of one’s social and personal identity and purpose.
It might be too early too sell. Mark Zuckerberg was famously offered one billion USD to sell Facebook at one point, an offer he obviously refused. While perhaps not a typical example, selling the family firm too early can also entail a massive opportunity cost for one´s family. Furthermore, if your family firm has survived the first few generations, it has most likely become a highly effective family firm. As the research of professor Kammerlander and others demonstrate, family firms outperform publicly listed firms on important criteria, such as on innovation, for instance, thus there is no reason to believe that a portfolio of blue chips should outperform a well-functioning family firm in absolute terms.
When relatively large dividends might be paid out over time, then a more diversified portfolio might be developed in parallel with owning the family firm – as already discussed. But, it is typically not easy to find circumstances that allow for such sizable dividends over time.
Now that you have sold, please remember…
Let me here share these issues that seem particularly key:
To maintain entrepreneurial capabilities in the family seems key. This would typically be enhanced by members of an owning family being involved as active board members in various direct private equity investments and ventures. Ownership positions in such companies would be important. A more active involvement than from simply owning stocks or bonds would be called for.
The owning family members must be comfortable with going from a situation where they would typically manage a relatively large group of employees, with an element of hierarchy, to managing relatively few people, often relatively detached (i.e. the portfolio) and networked.
To be open-minded and analytical is key. The search for new elements in one’s portfolio calls for this. To develop a basic understanding of what might be critical success factors in a particular niche is important here. Learning new skills will increasingly be called for, in addition to leveraging one´s experience. It follows that a degree of focus would be key also at the portfolio stage. Strategy means choice!
In General
In general, we have seen that to evolve from owning a firm to owning a portfolio is a doable task, but difficult. There are no easy answers. Often, this very transition process can lead to quite significant value losses for the owning family. In other cases, however, the sale of the family firm might save the family from long-term value destruction, and even ruin. It seems to me that various permutations of middle ground positions offer the most attractive possibilities for augmenting and protecting long-term wealth.
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