Investing in family-controlled businesses requires a good amount of patience and a measure of faith, but the benefits are hard to ignore.
Exactly what constitutes a family-controlled business varies, but a general definition is one in which the company founder and/or descendants have a significant economic interest in addition to a voting stake that is enough to influence the board. These voting stakes are often augmented by prominent positions within the company such as a seat on the board or a C-suite position.
Research over the last 10 to 15 years from Credit Suisse, Boston Consulting Group and McKinsey & Company suggests that family-controlled businesses outperform their non-family-controlled peers.
So where does the patience come in? Family-controlled businesses typically take a long-term approach to their business. Often times, they are conglomerates. They are looking for investments that might not yield compelling returns the next quarter or even the next year. But the good ones will add real value over time. They tend to not overextend their balance sheet, are mindful of borrowing, and do not take unnecessary risks or swing for the fences.
While they may favor long-term capital preservation and value creation, the well-run businesses aren't content with just sitting on their assets. They are aggressive in taking advantage of opportunities and they think about how over time they can change the trajectory of the business to create more value.
These companies and the families behind them like to take stewardship of the company's capital and drive it to create value over longer periods of time that compounds to the benefit of investors.
The element of faith, is important, too. This is partly due to family-controlled businesses' long-term trajectory, often spanning several generations, but also because they do not hold the same attitude toward their shareholders as their non-family controlled counterparts.
Simply put, the focus is not on meeting the needs of the shareholders. It is instead fixed on creating and building the wealth of the family. They can be less transparent than other businesses and research shows that family-controlled businesses are significantly more likely to have a higher percentage of interested board directors, which often includes family members.
Many family-controlled businesses do not disclose their long-term plan metrics and a significant percentage do not include financial targets.
Moreover, the overarching strategy pursued by leaders of family-controlled businesses is not always clearly laid out or communicated. Some, like Vincent Bolloré, chairman and CEO of French conglomerate Bolloré, which controls media giant Vivendi, which in turn owns Universal Music Group, can be ruthlessly aggressive because they take such a long-term view of the business. They may not care what the markets think in the short term and are often cryptic about their big-picture strategy for the conglomerate.
That lack of transparency can be frustrating to shareholders. They often do not want to wait for the complete picture to emerge over time. They want to see it every step of the way.
But for the patient investor capable of putting a measure of faith in the CEO's vision and business acumen, the payoff is the opportunity to ride the coattails of the family as they work to create value over time and compound their wealth.
That said, not all family-controlled businesses are the same and there are always risks that need to be examined. Investors should look at how the family has transacted with the company over the years. Are they good stewards of the company's capital? If they treat the business like their personal piggybank, that is a huge red flag.
Succession is another area that bears watching. Nepotism is always common in family-controlled businesses, but you want to see a process in which successive generations of the family earn their positions and learn the business from the ground up. Not all include family members in the management ranks and instead keep them in the boardroom. There is no one right recipe.
The companies that fill management with cronies are not likely to be the ones that live on and grow from generation to generation.
There are always companies to be avoided, but investing in family-controlled businesses focused on compounding value and family wealth — and that can adjust with the times and each successive generation — offers shareholders a long-term opportunity that is like investing with a top-tier money manager. The pay-off awaits.