Family firm going public - Essay Example

Family firm going public The family business is flourishing in many developed and developing countries throughout the world. It is a particular breed of business that can be more clearly understood by keeping in mind the idea of two interconnecting but separate systems. The family and the business are two systems in that the goals, needs and tasks of each are not identical. Because of the ambiguous nature of the interconnection, problems can and do arise. Methods for sorting out the roles and rules for the two systems need to be consciously developed and understood (Bogod & Leach, 1999). The advantages of running a family business are worth reiterating. They bear closed resemblances to those voiced by entrepreneurs generally - a feeling of freedom, a provision of income and capital, a sense of creativity. Family businesses can be a satisfying way to provide a living and for family members to feel collectively rewarded for their personal sacrifices. Under the best of circumstances, the family firm can provide a basis for meaningful and enduring family connections. Although there are many advantages, the concept of family business is not free from disadvantages. One such disadvantage arises when the procurement of capital comes into picture. Few, family firms reach this stage, which comes about when the business needs additional capital to continue its operations (Sitorus, 2001). Capital is procured by going public, usually concurrent with the introduction of professional management. "Often at this stage the family firm ceases to exist and the company becomes a publicly owned, professionally managed enterprise." (Monteith, 1995). Whether or not to 'go public' is an important decision in the life cycle of a company. Going public involves having the shares in a company quoted on a stock exchange and companies usually go public via an initial public offering (IPO) of their shares to investors. Stock exchanges serve two main functions: to facilitate the raising of new equity capital, and to enable trading in shares and other securities to take place. The capital-raising function is usually referred to as the primary market and the subsequent trading as the secondary market (Monteith, 1995). It is important to an economy that both markets operate efficiently. Similarly, a liquid a transparent secondary market will encourage investors to participate in the stock market and should again increase the availability of equity capital and lower investors' required returns. (Sitorus, 2001) Until recently limited liability was only available to limited companies, which ruled out sole traders because the company had to have at least two shareholders (Kline, 1994). Many traders go round this by setting up private limited companies, with another member of the family holding nominal accounts of shares to qualify for company status. They remained, in reality, one person business. There is now the possibility of limited liability for shareholders companies. There is no upper limit to the number of shareholders. Many family businesses are organized as limited companies but others prefer the informality of remaining unregistered (Marchisio, 2003). Many family businesses have been started on this basis and some have grown to considerable size within this format. The main limitation is that shares cannot be made available to the public, which restricts the company's power to raise additional capital through new shares (Bogod, 1999). By inviting members of the public to subscribe to the business, it enjoys much wider opportunities to raise funds. Going public also gives existing shareholders greater liquidity as they can now realize the value of their shares by selling them on the open market (Newman, 1985). Since the shareholders in a family firm may be quite wealthy in terms of the value of their business but at the same time have relatively little spare cash for personal consumption, going public allows them to enjoy a higher lifestyle without losing the business. As long as 51% of shares remain in the family hands they retain outright control. As more shares are sold there is a greater risk of outside shareholders outvoting the original owners and the possibility that they ill lose control of the business. A company dedicated to expansion may seek to go public to facilitate mergers and takeovers. Buying another business is made easier if the company can offer shares in payment rather than having to produce cash to compensate the target company's shareholders. Of course, by the same token, it may become the subject of another firm's growth strategy as occurred in 1985 when French Kier, one of the top twenty UK construction firms, was snapped up by the much smaller C.H.Beazer. Thus the main reasons for a firm going public can be summarized in the following points (Poutziouris & Sitorus, 2001): raising funds to finance capital expenditure programs like expansion, diversification, modernization etc. Financing of increased working capital requirements; Financing acquisitions like a manufacturing unit, brand acquisitions, tender offers for shares of another firm, etc; Debt financing; Exit route for exiting investors. Going public for a family firm does not necessarily mean loss of either legal or economic ownership. The former is avoided when a majority of the shares is kept personally or in trust but the latter will still remain if a significant share of the equity is kept or management control is maintained. Going public, therefore, can enhance the ability of a family-owned capital to expand. However, it is to be noted that in many cases it is a step towards the separation of ownership and control which is so characteristic of common law economies. The owner-manager who raises funds for investments from outside investors, the founder family that sells out to a new management team, or the firm that floats a minority stake in a subsidiary - all change the ownership structure in floatation. Ownership matters for the effects it can have on the management's incentives to make optimal operating and investment decisions (Sharma, 1998). In particular, where the separation of ownership and control is incomplete, an agency problem between non-managing and managing shareholders arises; rather than maximizing expected shareholder value, managers may maximize the expected private utility of their control benefits (say, perquisite consumption) at the expense of outsiders. The existence of such agency costs has long been recognized. However, they would appear to be particularly pertinent to family firms going public and raising large amounts of money, as opposed to the more usual scenario of rights issues by large already listed companies whose managers hold only tiny equity stakes. Besides, the ownership aspects there are many more such benefits which a family firm enjoys once it goes public. All these advantages could be summarized in listed under the following points: 1) Obviously, additional firms are raised 2) The disclosure and outside monitoring may make it easier to raise additional funds in the future. 3) A public price is established, and its subsequent behavior is a test of the performance of the firm. 4) It is often useful to have public prices, which establish values for tax purposes. 5) Increased liquidity is provided because of the market that may develop in the stock. 6) Enhancement of corporate visibility and profile as a means for securing new sources of finance, building strategic partnerships and attracting talented employees. 7) Creation of partial liquidity for the entrepreneur while retaining a measure of managerial influence over business operations. 8) Money non-refundable except in the case of winding up or buy back of shares. 9) No financial burden i.e. no fixed rate of interest payable. However, in order to service the equity, dividend may be paid. 10) Enhances shareholders value if the company performs well. 11) Greater transferability 12) Trading and Listing of securities at stock exchanges. 13) Better liquidity of securities. 14) Enables valuation of the company. 15) Helps building reputation of promoters, company and its products/services, provided the company performs well. The main reason for going public is to raise capital. But even a thriving business that can do all its financing internally may want to sell stock. Microsoft went public in 1986 to provide stock options with which to motivate its employees, and you can't argue with the results (Yatin, 2002). Some family-owned companies go public to provide liquidity for estate planning. Another motivation for offering shares is that it keeps a company on its toes. Once in public view, corporate assets are exposed to buyout offers. Any private company with decent earnings history and a plausible business story- high technology or low -will find investors very receptive to an offering of shares. The money is tempting. But you have to weigh the benefits of having new capital and new partners in the form of stockholders with the negatives (Yatin, 2002): 1) Once your company is public, it is accountable to a different type of stakeholder. Pension and mutual fund managers will tell you how to run your business. 2) Publicly held companies must bare their souls. There is no doubt that Microsoft's very liquid stock and the options that go with it has been a great magnet for talent. But is there any doubt that public knowledge of the company's fat profit margins has made it a much more tempting target for the government's trustbusters 3) If the share price were to escalate, that could have leave your heirs with a much higher estate-tax bill. So what if Wall Street is so eager to get into your industry that it will buy some of your shares for twice what they're worth You may be better off holding on to all of them and leaving them on your estate tax return at a low value. 4) Private companies don't have to play by the same rules as public ones. Try convincing the board of directors of a public company to make your daughter or son-in-law the next chief executive. Many private companies are run by second generation (or later) members of the founding family. Sometimes that's good for the company, sometimes not-but at least the founder gets to give the kids a chance. 5) Private company executive don't stay awake at night worrying about a hostile takeover. Once in a blue moon an outsider may launch a tender offer, hoping to snatch shares from a dissident family member. But most private companies are takeover-proof. Share prices in the private company are usually more stable since there is no public market for the shares. Employees therefore watch the bottom line rather than the stock ticker. 6) Private companies don't have to worry about a management coup. Andrew Corp of Chicago went public in 1981 to raise capital to meet MCI and Sprint's demands for its telecommunications equipment. Worried that a corporate raider might attempt a takeover, the board changed the company's bylaws to eliminate cumulative voting for board members by shareholders. The change in the voting structure, however, also meant that family members could be voted off the board- which is precisely what happened a few years later. These could be well - summarized as: Some loss of control is involved in sharing ownership. The activities of the firm are now more fully disclosed. More formal reporting to public agencies is required. This can be costly. If the firm's shares do not attract a following, the market for them may be relatively inactive, thereby losing the potential benefits of performance evaluation and aligning incentives. Outside investors may push for short-term performance results to an excessive degree. Dilution of ownership stake makes the company potential vulnerable for future takeovers. Involves substantial expenses ranging between 4% to 15 % of the size of the issue. Several legal formalities. Transparency requirements and public disclosure of information may lead to lack of privacy. Continuous compliance of provisions of listing agreement and other legal requirements. Constant scrutiny of performance by investors. May lead to takeover of the company Securities of the company may be made subjective to speculative attacks. CONCLUSION: The decision by a company to go public is a critical one as it results in the dilution of ownership stake and the diffusion of corporate control. During its life, a company must make the critical decision of it, and when, to go public' by listing them on the stock exchange. Going public has profound implications for a business, it has its own set of advantages and a set of disadvantages. The literature review on the family firm going public gives a clear picture that though have been cases whereby the firm got benefited because of the various advantages of going public, still these companies have faced a large number of obstacles which took a long time and various strategies were formulated and implemented by the firms to overcome these difficulties. Going further, if a family firm prefers to go public in order to raise its capital, then it needs to consider the various obstacles which it might face and thus good strategies needs to be proposed and implemented in order to overcome such hurdles. REFERENCES Chrisman, J.J., Chua, J.H., Sharma, P. (1998), "Important attributes of successors in family businesses: an exploratory study", Family Business Review, Vol. XI No.1, pp.19-34. Cromie, S., Stephenson, B., Monteith, D. (1995), "The management of family companies: an empirical investigation", International Small Business Journal, Vol. 13 pp.11-34. Daily, C.M., Dollinger, M.J. (1992), "An empirical examination of ownership structure in family and professionally managed firms", Family Business Review, Vol. V No.2, pp.117-36. Krips Newman, P. (1985), "The pros and cons of going public", SAM Advanced Management Journal, No. Winter. Leach, P., Bogod, T. (1999), "The Guide to the Family Enterprise", Stoy Centre Publication, London, Morris, M.H., Williams, R.O., Allen, J.A., Avila, R.A. (1997), "Correlates of success in family business transitions", Journal of Business Venturing, Vol. 12 pp.385-401. Pettit, R., Singer, R. (1985), "Small business finance: a research agenda", Financial Management, No. Autumn. Poutziouris, P., Sitorus, S. (2001), "The financial structure and performance of family and private companies", Corbetta. Poutziouris, P., Chittenden, F., Michaelas, N. (1999), "The Financial Development of Smaller Private and Public Limited Companies", Tilney Fund Management Publication Liverpool. Ravasi, D., Marchisio, G. (2003), "Going public and the enrichment of a supportive network: some evidence from Italian initial public offerings", Small Business Economics, Vol. 21 No.4, pp.381-95. Kline, P. (1994), An Easy Guide to Factor Analysis, Routledge, London and New York, NY, Commentary by Yatin Bhagwat. (2002) The Role of Going Public in Family Businesses' Long-Lasting Growth: A Study of Italian IPOs by Pietro Mazzola, Gaia Marchisio. Family Business Review15:2, 149-151 Read More