Wednesday 4 November 2020 4:34 am

Forget the drama of Succession and The Godfather — family businesses can be a great investment

Maxime Carmignac is UK managing director of independent asset manager Carmignac

Companies with big family stakes are notorious for rows over ownership, control and succession — not to mention nepotism.

Accordingly, existing Environmental, Societal and Governance (ESG) ratings mark them down on governance, discouraging anyone looking to invest for responsible growth.

But if you dig a little deeper, there are good reasons to invest in them. 

We all know the stresses in family businesses because the stories are so good. Family rows about money are fascinating — just look at the popularity of the TV series Succession. 

But our love of drama overlooks the fact that tens of thousands of companies with big family or founder holdings go on generating returns and value year after year, for decades. Today, they represent 70 per cent of world GDP and 50 to 80 per cent of jobs in many countries. 

Contrary to TV fiction, business founders are not gamblers — they are builders. A family business starts with someone who has vision and determination. They thrive partly because they are aiming towards a wider purpose than the quarterly earnings growth holy grail of non-family companies. 

Often, it’s this purpose that drives innovation and investment in the long term. As the French writer Antoine de Saint-Exupéry put it: “We do not inherit the land from our fathers, we borrow it from our children.” The same holds true for family businesses.

Such companies can be more comfortable than non-family businesses at making decisions that don’t pay out quickly. Hired-hand chief executives have limited time to prove themselves and face pressure from short-term investors to show quarterly earnings improvements. 

This means that they couldn’t, for example, take an approach to that of Hasso Plattner, a founder of European tech company SAP. Through his own endowment, he founded the Hasso Plattner Institute in 2003 for digital engineering at Potsdam and Stanford. These provided a safe space for engineers to design a revolutionary transactional database which developed into the almost zero-response time SAP HANA software, which was handed over to SAP. 

SAP’s decision would have been impossible for a conventional board of directors — too drastic and too uncertain. But he had the freedom to think ahead, and now HANA is the SAP market leading software platform used by more than 12,000 customers.

Betting on the long term doesn’t necessarily involve excessive debt. In fact, family businesses tend to be less leveraged than other companies. The Carmignac “Family 500” database tracks global companies with a minimum of 10 per cent controlled by family, founders, foundations or trusts. This database shows that, on average, their relative level of indebtedness is approximately three times lower than non-family businesses.

Of course, the universe of investable family companies is vast, and diverse. Finding the gems requires a meticulous approach. When the British investment tycoon Terry Smith was asked what he thought about investing in family businesses, he told me that they made him think of this poem from Longfellow: “There was a little girl… When she was good, she was very good indeed, but when she was bad, she was horrid.”

So what should the canny investor look for?

For a start, geography matters. When it comes to performance, over the last 15 years, EU and US family businesses have outperformed non-family businesses by 50 per cent and 40 per cent in their respective geographies, while within emerging markets, family businesses have underperformed. Our database shows that US family businesses are the sweetest spot.

Size makes a difference too. While all categories of family businesses by capitalisation outperformed non-family businesses, mega caps recorded the best performance over the last 15 years — posting almost three times as much growth. Investing in family businesses should not be restricted to small and mid-caps, as there are clearly some larger family champions.  

The generation of the family also counts. First and second generation family companies tend to do well. From the fifth generation onwards, performance is more variable as the unique mindset of the family business becomes too diluted.

The percentage of voting rights owned by the family should also be considered for listed family businesses: too low (below 10 per cent) and you don’t benefit from the family business advantages; too high (above 80 per cent) and the minority shareholders are disregarded. Non-executive directors need the wherewithal to stand up for non-family shareholders. Investors should observe how executives are rewarded, especially if they are connected to the family, and monitor corporate behaviour and the quality of accounting practices.

In short, good governance cannot be weighed by ticking boxes. It demands an active approach, combining human insight and independent research. With this, investors can marshal the information needed to spot a corporate formula that will build long-term value for investors, while contributing to the greater good.

Main image credit: Getty

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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