All in the family?

Family-controlled public companies face challenge of serving three interest groups

BOB NEAPOLE and MATTHEW WAI-POI

Value-creating companies generate returns for shareholders by maintaining strong competitive positions, being efficient operators and maximising capital utilisation. This is called ``competitive advantage''. Successful companies are continuously evaluating opportunities and investing in those that create or enhance their competitive advantage to deliver returns in excess of the cost of capital. These same companies also understand that it is more value creating to return cash to shareholders than to invest in projects likely to earn less than the cost of capital.

Family-controlled public companies have interesting dynamics from a shareholder value perspective. Management is often faced with the challenge of satisfying the needs of three different groups of shareholders: the current family owner-operators, the future family owner-operators (generations that will inherit the business) and public minority shareholders. These groups may have different expectations, motivations and investment time horizons, contributing to a degree of natural tension between shareholders. How can management ensure that value is maximised for each group?

A value-based management (VBM) approach provides the tools and techniques to determine if opportunities will create or destroy value. Importantly, it allows management to assess, in value terms, the trade-off between alternative capital investment and dividend distribution strategies. Value-based management can play a vital role in helping family-controlled public companies achieve a balance that satisfies all shareholder groups.

For example, current family owner-operators often rely on dividends for a large part of annual remuneration. Taken to an extreme, pursuing a high-dividend policy could limit the company's ability to invest in profitable growth, resulting in a stagnant or declining share price. This group is unlikely to trade company shares, with near-term price improvements less important than dividend yield.

Conversely, security for future family owner-operators is assured by establishing a robust, well positioned and soundly capitalised business. Investing today for future profitable growth is thus a higher priority than near-term dividend distribution. Long-term share price appreciation is of greatest importance for this group of shareholders.

The third group, public minority shareholders, seek total shareholder returns (dividends paid and increases in the share price) that exceed a minimum required return. This group's investment horizon is the most variable and its shares are the most liquid. The public shareholder group provides an indicator of what the market believes about the company's strategy and long-term value-creation potential. Market sentiment is important, with the vagaries of public minority shareholders dramatically affecting the quoted value of the business.

A value-based approach enables management to proactively develop and assess alternative strategic options and to measure the value contribution of each. Management of a family-owned public company can understand the investment required to maintain and grow operations, as well as how that investment can be supported by cash flow.

Maximising cash flow ensures that current owner-operators receive sufficient dividends now, while at the same time providing the necessary reinvestment to secure a legacy for future generations. Importantly, this balanced view of both wealth generation and wealth preservation ensures that total shareholder value is optimised, delivering superior returns for minority shareholders.

Ideally, management requires a strategy that both generates current cash flow and builds for future growth. Value-based management helps evaluate the ability of competing strategies to do this, while using the discipline of total shareholder returns as the defining metric.

The shareholder value approach is ideally suited to family-controlled public companies. When properly implemented it can respond to, and balance, the different needs of shareholders. The optimal strategy will allow management to address dividend distribution and reinvestment needs in a manner that improves total value, ultimately rewarding all shareholder groups.

- Bob Neapole is a director and Matthew Wai-Poi a consultant in L.E.K. Consulting's Bangkok office. They can be reached at rneapole@lek.com or mwai-poi@lek.com.

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