Dennis Jaffe is a founding partner of Relative Solutions, a family business consulting company.
Cherry Reynard is a freelance journalist specialising in investment advice and wealth management.
Dennis Jaffe says:
Recently, families who founded and maintain control over public companies have seen the emergence of "activist investors" who challenge the family's stewardship of the enterprise. While the family usually has a special class of stock that allows them to maintain control over the company, the investors pressure the family, who are typically interested in more long-term performance and even legacy, to improve short-term performance and challenge their control over board seats and leadership positions.
Family enterprises should not be surprised to find themselves challenged by their new shareholders. When it decides to become public, the family may focus on its need for capital and the benefits it will bring to the family, without really facing the added complexity that having new partners will bring to it. When it invests, a large shareholder expects a voice in the company. The family now has the opportunity to be open to the insights and experiences that a new partner can bring.
Activist investors can be viewed by the family as nuisances who do not allow them to govern for the long-term welfare of the enterprise. However, Sarbanes-Oxley regulations demand that the enterprise has independent directors, and a level of transparency that the family may not be fully prepared for. We find that, too often, a family has not really anticipated how it will work with these new shareholders, and how their presence will affect their leadership.
The family assumes that because it retains "voting control" the company will remain firmly within the family's orbit. It doesn't really consider the shift from a closed system of sole family ownership to being part of an open system with divergent and sometimes argumentative groups of stakeholders. These changes include greater demands for accountability, public scrutiny and media coverage. Too often the family is used to non-disclosure and perhaps even secrecy. It may not have developed the skills or the habits to negotiate, be flexible and clearly define its position, or the attitude that it has to listen to the positions and concerns of others.
Family enterprises that go public often want to maintain their legacy as a family enterprise, preserve its values, and even maintain the active involvement of family owners in governance. Yet as a public company, the family generally experiences a significant reduction in its power and control. For example, before they can select a family member to leadership, the family prospect has to demonstrate his or her capability and face systematic oversight on their performance. The family may not be ready for such scrutiny. The family leader now must now serve several masters, family and non-family shareholders.
Activist investors can challenge a family's voting privileges on the grounds that they are making decisions for family reasons rather than the good of the business. When this happens the family must talk seriously with the dissident shareholders. Families can learn from public shareholders in other companies. Many public companies face challenges from activist investors, and many of them quietly settle their differences and work collaboratively with the challengers. Even a well managed privately-held family enterprise can have independent directors, whose presence can be a resource to the family.
The greatest danger to the family arises when activist investors exploit differences that already lie within the family by finding common ground with a dissident family branch or faction. Again, this happens within families that do not have a clear and effective way of resolving family issues, leaving some members feeling that they aren't heard or taken seriously by their majority relatives. In this situation a publicly-owned family enterprise can be served well by having an active family governance process whereby the family meets, shares concerns about the management and ownership of the business, and irons them out before they go to the company board.
Therefore, choice for the family is not between working with activist investors or not. Instead, the choice is how they work as a family to lead their family enterprise so it will not be vulnerable to confrontational investors, and how directly and actively they respond when the outside investors are dissatisfied.
Cherry Reynard says:
Activist investors are often seen as the major peril when opening up a family business to external shareholders. The cliché runs that vocal, short-termist hedge fund managers and other dissidents looking to make a quick buck will interfere with the long-term strategic direction of a long-standing, well-managed family company. However, if a family business wants the cash injection that external shareholders can provide, it will have to be prepared for those shareholders to protect their investment and,
contrary to popular belief, there can be advantages.
Far from simply being a necessary evil, activist shareholders can bring expertise to a family company that may have been run in the same way for decades. An engaged and active shareholder base can help companies improve their long-term decision-making and maximise their opportunities. They can provide intellectual muscle and a broader perspective to a business that may have previously been narrow in its focus.
Family companies can be set in their ways, slow to embrace new ideas and adapt to a changing economic climate. Equally, they can be more prone to factionalism than other companies. Activist shareholders can provide an independent perspective and rise above personal disputes. In most cases, if they are long-term investors, they will want to see the company develop consistently and sustainably and their interests should be aligned with those of senior management.
Activist investors can also act as the moral conscience of a company. One of the main ways in which investors exercise their power in the current climate is to ensure a company acts in a socially responsible way – witness the Rockefeller family's recent attempt to make ExxonMobil go green. Activist investors in this area can help ensure a company treats its staff and suppliers fairly. They can help a company minimise its impact on the environment.
Some may view this intrusion as a nuisance; but for many businesses these investors can perform an important risk management function. If businesses are looking long-term, they need to examine their social and environmental impact. There is both a reputational risk and business risk inherent in using poor suppliers or bad labour practices. These investors may have a wider reach than corporate management. They are well-connected with teams of analysts focused on ensuring that the companies in which they invest have no gremlins.
Of course, activist shareholders can also be used as an agent for change. If a family business has a senior board member who inhibits change and opposes reform, a well-managed active investor base can be used to bring about strategic development and move a company forward.
Although the image of activist investors as populist, short-termist rabble-rousers is certainly overdone, there is no doubt that many companies have been forced to face down investors who have tried to force an unwanted change in strategic direction. Any company open to external shareholders will have to devise a formula for managing activist investors who do not have the long-term interests of the company at heart.
Many of these demands will be vogue-ish. Media giant Pearson – in which the founding family retain a minority stake – defended itself against calls to take on more debt for strategic acquisitions. This looked over-cautious in the bull market, but is proving a prudent strategy in the bear market.
This type of investor can be dealt with by a management with a clear vision. Providing a group cultivates the support of its long-term shareholders, it can fend off disruptive elements in its shareholder base with relative ease. However, it requires a strategy and rewards effort. Management cannot afford to avoid confrontation in the hope of avoiding a public showdown.
Anthony Bolton, nicknamed the "silent assassin" for the pressure he has brought to bear on the boards of companies in which he has invested, says that companies need backbone to defend against vocal but ill-informed investors. He has seen companies compromise their strategic direction on the whimsy of shareholders holding tiny stakes to avoid public conflict.
If family companies bring in external shareholders, it often coincides with a change of direction, such as expansion. These shareholders can bring valuable expertise, an independent perspective and can help a company improve its risk management – a big advantage for a company over the longer-term. Shorter-term, self-interested yet vocal investors are always a peril, but can be managed successfully in order to preserve the long-term interests of management and investors.