It may come as a surprise that many listed companies are still under the influence of their founding family or a significant long-term shareholder.
As well as retaining a material proportion of the shares, they may control the votes, have seats on the board or hold management positions. Some of the most well-known companies on the stock market fall into these categories, spanning all geographies and sectors: from Tesla to H&M, Samsung Electronics to Berkshire Hathaway, LVMH to Softbank.
Interestingly, those companies where the founding family or long term shareholder retain a significant influence appear to outperform the wider market. A study by Credit Suisse which tracked the share price performance of a group of 1,000 companies with family ownership since 2006 claims this outperformance is as much as 3% on average every year.
The irony is that there are many potential problems that come with this continued influence. The three most obvious are succession, capital allocation and corporate governance. So what is it about family influence that can, in some cases, overcome these challenges and drive superior financial performance?
Succession
The principal impediment to the long-term success of family owned businesses is succession. For example, who inherits ownership and control when the founder retires or dies? Elon Musk, an early investor in Tesla who is now CEO and has the controlling shareholding, was mindful of this when he announced that his eleven children will not inherit his Tesla shares upon his death. Instead, Musk suggested the shares be passed to an educational institution, clearly feeling this would result in more reliable stewardship of his innovative company than his burgeoning brood. Should future generations retain an influence in the company, the danger is that they are not as capable as their predecessors and the company could deteriorate over time. Similarly, another risk to us as investors is the possibility that a family member could sell down their stake after it is inherited. In this scenario, our investment might suffer from downward pressure on the share price.
Brown-Forman, the US drinks company whose portfolio of global brands includes Jack Daniels, has been very successful at avoiding these pitfalls to ensure the smooth transition of responsibility between generations of the founding Brown family (they still retain a 51% stake, having listed the remainder on the stock market after the end of Prohibition). As an example, in 2021, the previous Chairman, George Garvin Brown IV, retired and was replaced by his brother, Campbell P. Brown, without any operational issues. Importantly, the selection process to work at the 153-year-old company is more stringent for family members than for normal employees. There is a ‘Next Generation Committee’ which aims to engage and inspire the sixth generation, from which future leaders will likely be picked. This emphasis on meritocracy rather than entitlement is a key ingredient to a fruitful partnership between external investors and a founding dynasty. The benefits are clear at Brown-Forman where the shares have delivered an average growth rate of 11% per annum over the last fifty years, which is as far as our data goes back.
The principal impediment to the long-term success of family owned businesses is succession.
Capital allocation
The second problem with some family companies is that – particularly as they mature and are passed down between generations – they err on the side of caution when it comes to spending the company’s capital. Family owned companies tend to spend a lower proportion of revenue on research and development (R&D) compared to their non-family peers. The paradox is that despite this frugality, their revenue and profit growth often outpace those of the wider market. This is because limitless R&D budgets do not necessarily equal financial success. The cautious influence of a long-term family shareholder can help avoid expensive vanity projects, focus more on practicalities such as routes to market and develop more efficient decision-making processes. In other words, they get more bang for their buck. Financial caution also results in a reluctance to take on leverage, or borrowing, to fund growth and a propensity to avoid large acquisitions. Leverage and acquisitions are both standard levers management can pull to fuel growth. The key is to use them with prudence.
Lifco, a listed Swedish holdings company majority owned by Swedish investor Carl Bennet, exemplifies restrained but highly effective capital allocation. Its business model is to acquire small companies in the dental, sustainability and demolition markets. The common thread linking these seemingly incongruous sectors is that Lifco finds them to be fertile hunting grounds for niche businesses with attractive financial characteristics such as high revenue growth and high margins. Bennet’s desire for a reliable and growing income means that 30-50% of profits are paid out in dividends. This imparts a sense of responsibility in management who reinvest the remaining profits selectively into new acquisitions. Importantly, they avoid large-scale deals which are usually more expensive and likely to add less value. Although additional debt will sometimes be taken on to fund particularly attractive deals, the majority are funded with cash. This controlled approach to mergers and acquisitions (M&A) has allowed Lifco to grow its dividend at an average annual rate of 17% since the 2014 Initial Public Offering (IPO).
Family owned companies spend a lower proportion of revenues on R&D compared to their non-family peers.
Governance
Criticisms are occasionally raised about the governance of family owned companies. For instance, when a family business lists on the stock market to gain an injection of external capital, they may choose to issue dual share classes: one for new investors and one for the founder or founding family with higher voting impetus. This can be problematic for the external investor, whose opinion will be less influential than that of the founding family, often regardless of the amount of shares bought.
Meta (formerly Facebook) is a prime example. Mark Zuckerberg – Founder, Chairman and Chief Executive Officer – holds 95% of the Class B shares whereas most other investors hold the Class A shares. One Class B vote is worth ten Class A votes. Through this structure, Zuckerberg enjoys 59% of the total votes with only 13% ownership of the total shares, allowing him to retain control of the company, while still being able to benefit from external investors’ liquidity. The problem is that checks on his power are therefore limited. In the Reality Labs division, he has so far invested over US$40bn into the Metaverse (a virtual world users can access by donning a virtual reality headset). However, this vanity project is yet to turn a profit and made a loss of US$13.7bn due to the amount being spent on continued development. Zuckerberg does have a strong track record and these investments may well pay off, but even large investors with a differing view of the future of communication will struggle to have a material impact on the direction of travel.
The cautious influence of a long-term family shareholder can help avoid expensive vanity projects.
In some cases however, family influence can contribute to a sense of responsibility and stewardship that result in superior standards of governance. Deborah Cadbury’s book Chocolate Wars tracks the progress of her family’s chocolate empire from its humble beginnings in Birmingham in 1824. She illustrates the benefits of their Quaker capitalist principles. Believing that cocoa was a nutritious alternative to gin – the tipple of choice in the early nineteenth century – the Cadburys grew the sales of their innovative products quickly. For instance, instead of excessive advertising, which they viewed as disingenuous, they relied on the quality of the product to grow the customer base. Their intention to do business for the benefit of society rather than personal gain along with their pious principles of hard work helped steer the brand to global popularity within only a few generations.
Modern standards of stakeholder capitalism in family owned companies are often supported through a foundation structure. This is the case with Associated British Foods, a UK listed company whose underlying businesses include Primark and Fortnum & Mason. The Weston family has a 56% stake, principally through the Garfield Weston Foundation, which donates £90m annually to a multitude of charitable causes across the UK. This commitment to multigenerational philanthropy gives the foundation a clear incentive to ensure Associated British Foods is managed responsibly with a long term-time horizon, since the company’s dividend is the ultimate source of funding
Conclusion
Not all quality companies are family owned, and not all families are good stewards of capital. Like any investment approach, nuance is required to identify those companies that will benefit most from the stabilising influence of family involvement. The constant that emerges in companies that overcome the hurdles around succession, capital allocation and governance are those where the family or large shareholder instils a long-term view. Preparing thoughtful and meritocratic succession plans, treating capital with care through focusing on cash generation, and engendering a sense of responsibility to investors and stakeholders are all key.
In their cult classic book Freakonomics, Steven Levitt and Stephen Dubner argue that ‘incentives are the cornerstone of modern life’. The alignment of incentives is a crucial tool for the long-term investor. If our aim is to participate in the trajectory of the companies in which we invest for decades to come, then aligning ourselves with management styles predicated on generational wealth preservation is surely a good place to start.
