The pros and cons of IPOs in family businesses
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Like many family business owners, Phil Dudderidge reached the point where he wanted to take some value out of the enterprise that he had built up over more than two decades.
Mr Dudderidge, executive chairman of the company, Focusrite, describes his decision to float it on Aim, the London Stock Exchange’s junior market, in late 2014 as “de-risking, from a personal standpoint”.
Focusrite makes audio equipment for both professional and bedroom musicians — picture the next Ed Sheeran with an acoustic guitar, microphone and a pre-amp recorder plugged into a laptop. Mr Dudderidge, a former audio engineer for Led Zeppelin, bought the company’s assets out of liquidation in 1989.
The IPO route does not appeal to all family business owners, however. They can be reluctant to dilute family ownership, because of the potential loss of control, and stock market investors sometimes worry that the families might be too self-interested to ensure good stock performance.
Despite the misgivings on both sides, there is evidence that an IPO can be good for both the family business and for its investors.
In Mr Dudderidge’s case, the decision to pursue a listing came as he approached “what might be called a retirement age”. He began to think about how best to pass on his family wealth, adding: “I’m not planning to retire but you never know when nature might decide these things for you.”
Weighing how to reduce his family’s ownership, he decided an IPO was preferable to a takeover by a competitor, because he did not want to sell the whole company. He also wanted to avoid bringing in a private equity investor because that route would not fit with the company’s debt-free business model.
Focusrite has performed well on Aim. Its share price has more than doubled since IPO, making it a positive example for those who argue that founder-owned companies perform better as public companies.
Not every IPO experience is so smooth for a family business, however. Toilet paper maker Accrol came to market on Aim backed by private equity house NorthEdge Capital in June 2016. By October 2017, it had warned on profits and suspended its shares, partly because of rising costs. Shares are trading again, but last week the group announced that its chief financial officer was stepping down after reporting a loss for the six months to the end of October.
Those running or working with family businesses argue that when pitching for external investors, it is important to be sure of the investment proposition. “If you are taking your company to market as a growth stock, you have to believe your growth story and be confident that you can demonstrate [it] for years to come,” says Mr Dudderidge.
His tips for a successful listing include picking your advisers carefully, and deciding whether you are offering share price growth or income to potential investors.
When family businesses do decide to bring in a private equity investor or to place shares with chosen institutions at IPO, it is important to make sure that any major external investors are a good cultural fit, says Elizabeth Bagger, executive director at the Institute for Family Business, a UK industry group.
“If you decide to give up part of the control, you want to make sure that the person understands what it means to buy into a family business,” she says. In fact, family businesses are increasingly setting out their values in special “constitutions”.
Ms Bagger sees more willingness from families to consider accepting public and private equity to fund growth, but thinks an information gap remains. “If you could bring more information to the family sector on what an IPO can bring in benefits, more people may consider it,” she says.
Differences of opinion among family members on whether to accept external investors are common. One way to resolve such disputes is to set up a kind of internal share market to buy out relations who do not want to proceed to the public market, says Ms Bagger.
Do listed family businesses perform better?
Listed companies that come with a substantial family ownership and voting rights are often popular with investors that have a long-term investment strategy. They are seen as less enslaved to the short-term reporting cycle, and less likely to take on excessive debt or resort to accounting gimmickry. “They think in quarter centuries, not quarters,” says Ms Bagger.
Studies suggest that family businesses actually perform better, as investments, than companies with a broader ownership base. Credit Suisse publishes an index of family-owned companies that it says has outperformed the wider market over the past decade, regardless of region, sector or size. Its index performed better than wider equity markets by an annual average of 4 percentage points since 2006.
Eugène Klerk, one of the authors of the Swiss bank’s report on the index, says this share price performance is supported by generally higher revenue growth from these companies. “We also find that profitability is higher and that funding . . . tends to be more robust, more conservative,” he says.
The experience of Focusrite bears this out.
“Once you break through the stratosphere and you are actually generating cash as a business, you never want to go back [to not being cash flow positive],”says Mr Dudderidge. This strategic focus is popular with investors that prioritise cash management over quarter-to-quarter profits.
Mr Klerk acknowledges that the remuneration policies of family businesses contribute to weaker governance, compared to non-family peers. However, this “doesn’t seem to correlate at all to a weaker operational performance”, he adds.
For more on how family businesses perform on the stock market, including an interview with Focusrite’s Phil Dudderidge, listen to this podcast.
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