When engaging in shop talk about a client project, our colleagues inevitably start by asking, “What business is the client in?” In nearly all cases, the appropriate response to the question is a brief description of the client’s industry. But for a small minority of clients whose financial performance is truly extraordinary, the correct response is that they are in the “money making” business. For these clients, the particular “it” of what they do is secondary to the fact that they make a lot of money doing it. Has your family business joined the exclusive club whose members are in the “money making” business?
At a recent meeting with longstanding family business clients, management mentioned that one of their independent directors had introduced the term “lazy capital” into the family’s vocabulary. We had never heard that term before, but it perfectly encapsulates something we see at too many family businesses: an undisciplined capital allocation process that tolerates sustained underperformance. We ran across a couple articles this week that, while written with public companies in mind, made us think about the perils of “lazy” family capital.
In last week’s post, we explored how to respond to unsolicited acquisition offers. This week’s to-do list is about being prepared for such offers if and when they come.
Successful businesses don’t have to go looking for potential acquirers—potential acquirers are likely to come looking for them. Most of our family business clients have no intention of selling in the near-term, and yet they often receive a steady stream of unsolicited offers from eager suitors. Many of these offers can be quickly dismissed as uninformed or bottom-fishing, but serious inquiries from legitimate buyers of capacity occasionally appear that require a response.
The Founder’s Exit Doesn’t Need to Be the End of the Story for Shareholders
Management transition is a sensitive topic for many family businesses. Founders of successful family enterprises are by definition exceptional individuals. The challenge for family business directors is ensuring that the unique attributes of key managers contribute to the sustainability of the family enterprise instead of crippling the business through unhealthy over-reliance or dependence on a single individual. Pitt Hyde’s (AutoZone founder and long-time director) recently announced transition highlights three lessons for family business directors and managers.
Takeaways from General Electric
The recent announcement that General Electric is slashing its shareholder payouts by more than 90% has put dividends in the headlines in recent days. The news coverage provides an opportunity for family business directors to re-visit dividend policy at their own companies. While we wouldn’t want to suggest that the GE dividend news tells savvy family business directors anything they didn’t already know, a few reminders about dividend basics seem fitting.
It may be a tiresome cliché, but your family business really does make money buying low and selling high. It’s important to think about gross margin, because it tells you how much of a “mark-up” your customers are willing to pay for your good or service. The higher the “mark-up” the more revenue will be available to cover operating expenses and generate an operating profit.
The income statement is a natural place to begin analyzing a company’s financial results, and revenue is the natural starting point for that analysis. We recently heard someone remark that everything good in business starts with revenue, and our experience working with family businesses of all stripes confirms that sentiment. While the absolute amount of revenue can be instructive (i.e., are we looking at a $10 million business or a $100 million business?), it is the trend in revenue that is most revealing. Is the business growing, treading water, or shrinking?
Talking to the Numbers Introduction
Reading financial statements well is all about asking the right questions. In this series of posts, our goal is to help family business directors ask the right questions of their financial statements. Asking better questions leads to better financial and business decisions.
If family business directors are going to make good capital allocation decisions, they need to know what the right hurdle rate is. If the hurdle rate is set too low, the family may experience weak future returns. Setting the hurdle rate too high, however, introduces the risk that the family business will pass on attractive investment opportunities. In this post, we consider how the hurdle rate relates to the weighted average cost of capital.