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Family businesses: an attractive investment prospect

September 2020

When family values bring shareholder value

Family businesses can be an attractive investment prospect for investors, but capturing these opportunities requires an active approach.

Family businesses are the backbone of the global economy. They contribute between 50 per cent and 70 per cent of countries' gross domestic product and employ the majority of their workforces. But there’s a widespread misapprehension that these companies are just small, local operations and so largely inaccessible to investors. Nothing could be further from the truth.

There are in fact hundreds of listed companies that count founding families as shareholders. They operate in every global industry and sector and come in various sizes – large, mid and small cap – and are held by a wide range of professional and non-professional investors. They are as diverse as Hermes, Dassault Systems, CGI and JD.com.  Many have taken on outside finance in order to grow or meet inheritance tax liabilities or to allow family members who wish to pursue other interests to cash out.

Society's true backbone, both economically and socially
Society's true backbone, both economically and socially

Source: Tharawat Magazine, Economic Impact of Family Businesses – A Compilation of Facts, 06/01/2016 – over 40 sources used including IMD and KPMG *Data representative of private employers only

Although there is no consensus as to what constitutes a family business, we at Pictet Asset Management believe the label should apply when a family or founder has a controlling stake in the company. We define this as the family or founder holding 30% of voting rights. The 30 per cent figure might seem arbitrary at first glance, but it is based on the fact that, on average, only 60 per cent of eligible shareholder votes are cast at any one time.

The family factor

This definition opens up a universe of high-quality companies to investors. A number of studies have shown that family-owned publicly-traded companies have historically tended to outperform the wider market, including a recent piece by Credit Suisse1.

According to this reseach1, family-owned public companies have stronger revenue growth than their peers, which tends to result in outsized shareholder returns. Family companies also have better margins – 190 basis points vs 150bps. And they have more conservative balance sheets, with 22 per cent lower gearing.

Financial commitment
An unparalleled dedication to disciplined growth
An unparalleled dedication to disciplined growth

Source: Credit Suisse Research Institute, the Family Business Model, July 2015

This isn’t down to a small company, sectoral or regional effect. Family-owned businesses tend to outperform their non-family peers, even when results are adjusted for each of these factors. 

So why do family businesses outperform?

We believe there are three primary reasons. First, because the families tend to have most of their wealth and reputations invested in these companies, their interests are closely aligned. This, in turn, leads to the second reason, that family businesses often reinvest a larger proportion of their profits than their peers. Finally, stability of ownership also allows management to take a long-term view, rather than obsessing about the next quarter's profits. Their capital expenditure as a proportion of depreciation is higher than average.

History has shown that family businesses operate with stricter financial discipline while at the same time making better investments.

Despite all this, many investors continue to shy away from listed family-controlled companies. Concerns often centre on the liquidity of the investment and the quality of the governance structure.

But such worries are often misplaced.

Even by Pictet AM’s stringent criteria – 30 per cent family ownership and a minimum of USD5 million daily stock exchange liquidity – there are some 500 companies globally that qualify as listed family businesses.

In terms of governance, it is clear that close monitoring is needed when there is a high degree of concentration of influence2. For example, some investors argue for increased independence of corporate boards – but we believe this could negate some of the advantages of family ownerships. Indeed, research shows that, within family businesses, greater board independence doesn’t improve company performance, all other things being equal3. Instead, independence and strong leadership of the firm’s audit, remuneration and nomination committees are as essential as checks against powerful family board presence.

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Other common issues that can arise from concentrated ownership includes damaging family squabbles, or inadequate succession planning. Here too, it’s a matter of closely researching the company’s legal structure and any other governance agreements and ensuring that they’re being followed.

Investors also need to be aware that, although family-owned businesses run the gamut of small to mega-cap, are found across developed and emerging markets and across sectors, they don’t mirror the wider market. They are more heavily weighted towards consumer discretionary, communications and consumer staples sectors – there are fewer such firms operating in finance and energy. 

So while family-owned businesses are attractive prospects for investors, getting the most out of them – which is to say, avoiding hazards and maintaining a well balanced portfolio – necessitates close analysis and a well calibrated, active approach.