Two things have been in my mind in the last week or so.
Firstly, Christmas – and what will surely be a very different Christmas for many of us this year – seems to have crept up from nowhere. In my world Christmas is usually a time when I can take some meaningful time out of the business, so it inevitably becomes a time of reflection.
Secondly, and following on from the first: family. Christmas and family go hand in glove.
I happened to recently pick up a piece by the late philosopher, Roger Scruton, about family. He put it thus: “In families, people often get together to discuss matters of shared concern. There will be many opinions, conflicting counsel, and even factions. But in a happy family everyone will accept to be bound by the final decision, even if they disagree with it. This is because they have a shared investment in staying together. Something is more important to all of them than their own opinion, and that is the family, the thing whose welfare and future they have come together to discuss. To put it another way the family is part of their identity; it is the thing that does not change, as their several opinions alter and conflict. A shared identity takes the sting from disagreement. It is what makes opposition, and therefore rational discussion, possible; and it is the foundation of any way of life in which compromise, rather than dictatorship, is the norm.”
I then put this Christmas reflection and the idea of family identity together with the annus horribilis for most businesses that has been 2020. What does it mean for the family business?
Here is what I think:
We know, anecdotally, and there is academic evidence to back it up (Gordon Nicholson 2010), that family feuds are one of the greatest threats to family firms. Healthy family relationships, such as those in families where members support each other and openly discuss various views on business related topics, will probably exhibit more comprehensive strategic decision making. In contrast, family relationships that spill over into conflict within the business can undermine the effectiveness of even the most successful family firms.
Comprehensive strategic decision making will most certainly be of heightened importance in the months ahead.
Why family business is different
When the usual rules of corporate finance are applied to family firms they largely go out of the window. This was true even in “normal times”. Some fundamental things need to be viewed from a slightly different perspective in a family business: the relationship between risk and return, the blanket assumption that investors will always behave in an economically rational way, the understanding and consideration of non-financial preferences.
A good place to start thinking about this is with the assumptions inherent in the “capital asset pricing model” (CAPM). This is the staple methodology used by investors to make decisions about the value of their investments. The following are fundamental to the capital asset pricing model:
- That there are many investors seeking to diversify their investment.
- That all investors are looking at the same, single-period planning horizon.
- That all investors are looking to maximise only economic utility.
- That all investors have the same information about investment opportunities.
- That assets can be sold at market price at any time and that all investors have equal access to all assets.
These assumptions are seriously stressed, to the point of being almost meaningless, for a family business. For example:
- The family business usually has a low number of investors, typically the family members.
- It has its assets held in a very undiversified way: namely 99% of wealth is typically tied up in the family business.
- The time horizon is for the long term, with the intention that wealth will be passed from one generation to the next.
- Family members are usually concerned about social and emotional utility, not just economic utility.
- The controlling shareholder, which may even itself be a bone of contention within the family, is often involved in direct management and has huge information advantage over any other outside investors, including more distant members of the family.
- Finally, the market for ownership stakes in family firms is firmly illiquid. They are tyically “not for sale”.
Family business valuation and transactions in 2021
I get asked about business valuation all the time. When you think of valuation in the context of a family business you can see it can never really be understood as a scientific endeavour. The valuer will work with reasonable assumptions and accommodate the peculiarities of the case, different methods and so on. But value and price may well differ significantly: as for any other economic good, “supply and demand” is central to the determination of price. What is a willing buyer prepared to pay to a willing seller (assuming the thing is for sale in the first place)?
As Scruton points out, “family is part of identity; it is the thing that does not change”. In practice we usually assume, at least to some degree, that the transfer of the firm within the family is not only the best option for both the firm and the family, but the option that is most preferred.
But I wonder if we will be challenging that assumption now? The one thing 2020 has presented, more than anything else, is change. The rhythmic rise and decline of markets, products and technologies give rise to the question of how best to approach family succession anyway. But what about on the back of the year we have just had? How do unchanging family firms, where consistency is fundamental to identity, deal with change? How do family firms create value across generations in this environment? I think these are going to be important questions for family businesses as we go into 2021.
At Scrutton Bland we deal with family businesses daily. Many of the traits of a family business are evident in our own business, a partnership. Please talk to us if any of these issues resonate with you as we move into 2021.
In the meantime, I wish you and your families a very Merry Christmas and Happy New Year.