The following article will be taking a look at the key issues that a family in business needs to consider and provide answers in relation to the divergent perspectives of Custodians/Stewards of the family business versus those with a value-out mentality towards ownership.
Custodians or Value-Out Owners?
Between these two types of owner mentalities within family businesses, there are fundamental differences in attitude. For Value-out owners are those who expect their investment to produce a market return, mainly in the short to medium term. On the other hand, those who have a longer term investment horizon and place importance on the long term legacy of the company are referred to as custodians or stewards.
Having clarified the difference between the two views, it must be clarified that one type of owner is not better than the other. The point to keep in mind is that these two attitudes to ownership within a family business will have a huge impact on the way the family business is organised and run. Custodians and value-out owners have different expectations and as such measure success in different ways. Hence this is the reason that a family who aspires to continue in business together have a very clear idea on what type of owners they want to be.
The commitment of a value-out owner to a family business will depend mainly on receiving a satisfactory financial return. If this is not forthcoming then like any other rational investor s/he will want to be able to sell the shares and invest elsewhere to achieve a better return.
Custodians or Stewards
The custodian or steward, on the other hand, is more likely to accept trade offs between personal financial gains and other types of “return on investment”.
For example, the custodian may attribute value to the task of creating or maintaining a legacy of family ownership to pass to the next generation or in looking after the wider interests of a group of stakeholders, like employees, customers and suppliers. Even if some of these objectives incur a financial cost to the current owners, they still make sense to someone who has this custodian attitude to ownership.
This broad distinction is useful when setting the rules to control and manage the sale of shares in a family business. Value-out owners, with an investor mentality, will expect to have an opportunity to cash-in when they want or to sell if they are offered a premium price, perhaps even if that is by a competitor. This, however, would offend the custodian who is concerned about securing longer-term benefits of family ownership and consequently would expect there to be a more limited opportunity to sell.
Different Attitudes to Ownership in Family Business
The different attitudes to ownership also need to be reflected in how the shares are valued for sale, since in a private company there is no external market to do this. The value out owner is likely to expect full or open market value. This might mean revaluing assets (land and property) to reflect current market rather than book value, taking the goodwill value of the business into account (even if this is not on the balance sheet) and never discounting the share value even if the owner has only a minority stake.
The custodian, on the other hand, would be more likely to accept a valuation that has been reduced below open market value to reflect the fact that selling for personal gain goes against the grain of the custodian mentality which is about the long term and working for the greater good. In this case assets like property and goodwill are unlikely to be re-valued to increase the share price for an exiting shareholder.
It is important to understand that a custodian attitude does not mean that the family business can never be sold and that anyone who would consider doing this is always to be viewed as a value-out owner.
View of Custodians of Family Businesses on Return on Investment
Custodians do not focus on short-term returns in the same way as a value-out owner. They expect performance to be measured in terms of how well the family’s assets have been carefully grown over a longer period, which is often over a generation of the family.
The owners and executives in two different family enterprises, share an interest in creating long-term financial security for the family owners. This common interest and outlook will impact on their decision-making in similar ways.
For example, both families might decide it makes sense to reduce or even eliminate dividends in the short term in order to increase the strength of the business through funding longer-term capital investment or building up a war chest to fund acquisitions. The owners are also likely to accept the logic there must be a restricted opportunity to sell shares, because they are meant to be building value for the long term.
The other characteristic shared by custodians is the willingness to act altruistically. This means doing what is necessary without the need for others to reciprocate or without the expectation of reward. The custodian does what is needed to look after the common good because it is the right thing to do – as simple as that. In contrast, the value-out owner is far more about personal gain and autonomy.
Views of Value-Out Owners on Return on Investment
A value-out family believes that the common good extends to looking after their direct family now. They are proud of what their family has achieved through being in business together and how this has profited others, but they do not feel responsible for an extended group of stakeholders in the same way as they feel responsible for the family. Nor do they, for that matter, feel a particularly strong attachment to the type of business they are involved in or the place it is currently located. In the case where their business is struggling, a value-out owners, reasonably enough, may decide that their sense of custodianship can only be respected by selling and reinvesting in other assets that provide a safer return. To hold on to the business as its value declines would amount to a failure to look after the common good of the family.
The relevance of all this to practice is that it illustrates how subtle a family’s attitude to ownership can be and it pays to explore this in detail before plunging into detailed ownership structures and policies. The specialists coming from the legal or financial backgrounds should take note of these subtleties before advising their clients into structures that would in actual fact be the reasons for the downfall of the family business.