Consolidating ownership: when and why?
1st December 2017
Ownership in the early stages of a family business can be a relatively simple matter, but what happens when a firm moves into the second generation and beyond? Deciding how to approach ownership as the family business grows through generations is critical.
One question family business owners have to consider at one point or another is whether or not to consolidate ownership. This issue may arise when one shareholders is considering to giving up their stake in the business, or when a controlling owner might be thinking of buying others out.
In this article we look at why people might want to leave their family business and how that can be addressed.
Selling your shares
Family business shares tend to be illiquid, both because often there is no ready market, and because they usually tend to trade at a considerable discount. Moreover, family businesses may not be paying out high dividends because, reflecting the long term orientation typical of family firms, profits are reinvested in the business for growth and innovation.
Dividend policy is one of many issues that may lead shareholders to disagree about how the business should be managed. This can lead to stress and conflict, not easily solved within the channels available.
Furthermore, a shareholder may find themselves in need of liquidity to invest in a new business venture, to buy a house or pay for their children’s education. A simple solution to these challenges may be to allow them to sell up and move on.
Buying others out
One of the reasons family businesses often outperform non-family equivalents in the long run is unified vision and quick decision making.
However, when individual family members’ needs and objectives are not aligned to those of the business, conflict may arise. Disagreements between shareholders can impinge on the efficiency of the family firm, and ultimately on its success. Consolidating the ownership by buying others out has proven for some families to be an effective way to bring efficiency back into the system.
Natural processes of consolidation
Sometimes consolidation is a natural process. Fast-growing businesses can easily meet the financial needs of fast-growing families. However, if the family grows faster than the business does, this may mean the capital gets significantly diluted. As a consequence, shareholders with very small minority stakes may become more disengaged, leading to a natural and smooth consolidation (if you would like to find out more about shareholder engagement, access the IFB Research Foundation's publications).
On the other hand, some businesses may not need to consolidate because they have naturally handed the business down to one or a just a few members of the family.
Consolidating ownership can be very challenging, both emotionally and technically. We will explore more of the technical options in our next article.