Family Businesses

This week the discussion of financing a family business will be presented. 

Family businesses can impact the economy significantly and Smiths Gloucester has figures to prove this. http://www.smiths-gloucester.co.uk/cms/attachment_35.pdf

- Family businesses make up about 65% of all private sector firms
- They employ approximately 40% of private sector employees (1in3 jobs throughout the UK)
- Family businesses generated about 35% of private sector revenues (April 2012)
- They contributed under 25% of the total UK GDP
- There are more than 1000 firms with more than 250 employees

Some globally known businesses have started out as family businesses such as Ford, Warburton’s, Toyota and Walmart. 

The main difficulties families have in starting a business is raising the finance, which can make it difficult for the company to expand and grow. In order for a small/medium business to expand, listing upon the stock market is the best option, however, if the family is wishing to keep total ownership of their company the listing is not an option. The other option to raising finance if the family decide not to list on the stock market is to find a private investor who will be willing to invest.

However, family businesses don't produce documents beyond their annual accountants, and due to generally being private firms, information on the company is generally kept to the family making it hard for lenders to gain an insight into the business.
This can have negative succession effects that can extend beyond the family firm, impacting not only on the organisation but on the economy as a whole (Koropp and Gygax, 2012). 

One advantage of being in a family business is that there is a shorter chain of command which aids decision making. 

 

Sourcing finance is usually raised through family or other internal sources as the major source of finance within the business for initial expansion. (Coleman & Carsky, 1999).

Family businesses need to decide as a family unit how they are prepared to finance their business, and whether they will maintain the family unit if the business contains to expand exponentially to the point where financing through family, friends and credit is no longer possible.

Outside investors must realise that if they don't understand the family, then they will be unable to understand the businesses, and investors must be prepared to compromise or investor knowing full well that the family actions will come before their ideas.

Crowdfunding

In my previous blogs I have discussed ways to raise finance; however this blog is on the concept of crowdfunding which is something a little different.

Crowdfunding is defined as “An open call, essentially through the internet, for the provision of financial resources either in the form of donation or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes” Larralde (2010).

There are three types of crowdfunding and these include:

•      Civic Crowdfunding/Philanthropic Donations

•      Reward Based Crowdfunding

•      Securities Crowdfunding/ Equity-based Crowdfunding 

Multinational or larger firms may not deem this as an effective way to source finance as they can raise their finance through other sources as discussed in some of my previous blogs. However, it can be a very sufficient way to source finance for start-ups or new enterprises.

On the other hand, smaller business and entrepreneurs are liable to suffering from the financing gap; the problem that occurs when small to medium enterprises need funds, and would be able to use them productively if they were available, but are unable to access these funds through the financial system (Limming, 2011).

As start-ups or smaller business may find it hard to raise finance it seems crowdfunding would be beneficial to them as they essentially receive a 0% loan from their customers. This is because they appeal to customers or investors who would be interested in the project and are willing to invest in something they believe could be a success.

New websites have been created in order to help start-ups publish their project in order to get crowdfunding; these websites are called ‘kickstarter’ and ‘Indiegogo’ which allows users to provide content and interact with customers in order to gain finance.

The inputs of the individuals in the ‘crowd’ trigger the crowdfunding process and influence the ultimate value of the offerings or outcomes of the process. Each individual acts as an agent of the offering, selecting and promoting the projects in which they believe.

An example of crowdfunding on kickstarter is:

SWIMMING IN NEW YORK - +POOL

This New York project – featured on Goodnet earlier this year – raised $273,114 through Kickstarter to build a filtered, floating swimming pool in the middle of the river. The +POOL project began with the goal of cleaning the entire Hudson river, starting with one small piece at a time. After that it expanded - developing technology designed to filter the very water it floats on – and at the same time allowing New Yorkers to swim in clean river water for the first time in 100 years.

This type of crowdfunding was ‘Civic Crowdfunding/Philanthropic donations.’ Not all business ideas/projects are for generating profit and this project was originally intended to help the community.

However, companies must realise how much the venture will cost and they must set specific budgets in order for them to ensure they won’t fail. If companies have spent the funding customers have given them through crowdfunding and the company spends the money big problems could occur.

Crowdfunding is relatively new with many failed stories being told in the news, however looking at ‘kickstarter’ there are also many successful stories. By successful I mean companies have received the sufficient finance needed to start their business and employ their projects.

Finally, I believe crowdfunding is a sufficient and effective way for start-ups or small companies to raise the finance they need. It is also a great way to create a reputation and expose the brand image. However, companies see it as technically a 0% loan even though it’s not a method of raising finance, which can be a downfall to crowdfunding which start-ups need to be careful about.

 

Mergers and Acquisitions (M&A)

In this blog, I will discuss Mergers and Acquisitions (M&A) and what affects they have upon businesses.

A merger is defined as: the combining of two business entities under common ownership. (Arnold, 2008). There is a few businesses that have proven to be successful mergers, these include companies such as Glaxo and SmithKline and Kraft’s takeover of Cadbury.

There are 2 primary motivations for companies to make acquisitions:

• Fill a strategic gap in the company’s product, resources (people) and capabilities.
• Help the company enter a new market preferably with a revenue stream.

However, many companies worry with the takeover as the smaller companies will wonder what will happen to them. An example of this is when Cadbury’s had a worrying feeling that Kraft’s would turn them into an Americanised company. However, the growth and expansion of Cadbury’s since the takeover has proved it has worked and that the two companies can work together. Both companies benefit from this merger equally and this shows within their growth and expansion.

The main benefits of a merger include;

Synergy – This is where two firms together are worth more than the value of the firms apart.

Economies of Scale

Market Power

Entry to new markets and industries

Tax advantages

Risk diversification

Bargain buying – Which is where the target can be purchased at a price below the present value of the targets future cash flow when in the hands of new management.

Elimination of inefficient and misguided management.

Under-valued shares: “strong form, semi-strong form or stock market inefficiency.”

Managerial motives

Empire building

Status

Power

SurvivalFree cash flow

Third party motives

Advisers

At the insistence of customers or suppliers

GlaxoSmithKline is a prime example of a synergy as both companies separately weren’t

hugely well known whereas together they are a globally known company. The increased

value of both companies comes from the increase in revenue and the reputation of both

companies. Market power is an important driving force for mergers. Mergers are often

formed in order to ensure competitors are shut out. 

Economies of scale are an important contributor to synergy. Larger size usually leads to lower cost per unit of output. Mergers identify savings from sharing their central services such as administrative activities and accounting.

If a firm has lack of knowledge of a certain market, the quickest way to establish itself is through the purchase of an existing company in that specific product or geographical market. Furthermore, creating a new participant in a market may generate excessive competition, producing the danger of a price war and thus eliminating profits. This can be a major disadvantage for a firm.

Managers also play a big part in mergers. Superior management are created when two managers join forces, perhaps ridding of those managers who are not fully committed to the company but also the motives of the managers to build an empire can help the company to grow.

A recent example is Softbank Corp. and there recent bid to merge with T-Mobile, of which T-Mobile declined. In a bid to become an industrial leader the CEO of Softbank Corp has been trying to expand the business exponentially over recent years and has hit a wall with T-Mobile who has said no.

  

Although the merger discussions have created an increase in share price, the companies have yet to agree on a price. Here is a perfect example of the managerial effects within a merger, and perhaps here we can see the winner's curse, in that the Softbank CEO believes his company are unstoppable and will become a world leader, of which T-Mobile aren't playing along.

All mergers are not equally successful however, with a large number being unsuccessful, which can be linked to the attitudes of the managers. Shareholder approval is generally needed to allow for a merger, but as acquisitions can be unprofitable to the acquirer and wealth is transferred rather than gained, a merger may not always be in the favour of the shareholder.

The merger process has set rules and codes provided by ‘the city code on takeovers and mergers.’ The fundamental objective of the takeover panel regulation is to ensure fair and equal treatment for all shareholders. The main areas of concern are;

·         Shareholders being treated differently, e.g. large shareholders getting a special deal.

·         Insider dealing

·         Lack of adequate and timely information released to shareholders

·         The bid process dragging on and thus distracting management

The merger process

Overall, a merger may seem a good idea and there are many success stories out there where businesses have merged and there have been good outcomes for the business. However, the needs of the shareholders cannot be denied and a hostile takeover can only lead to a negative effect on share price. Company's therefore need to seriously consider the benefits of the merger, or even the impact of doing nothing upon the company's profitability and scope before making any deals.

There are three main reasons why mergers could fail;

·         The strategy is misguided

·         Over optimism

·         Failure of integration management

Foreign Direct Investment - a company's aim to invest internationally.

This blog discusses Foreign Direct Investment and it is defined as the purchase of physical assets, or a large amount of ownership (i.e. stock) of a company, based in another country to gain some form of managerial control. The investing company may make its overseas investment in a number of ways - either by setting up a subsidiary or associate company in the foreign country, by acquiring shares of an overseas company, or through a merger or joint venture.

 














This chart shows the foreign direct investment since the 1980's to 2007. The world total only begins to see a huge increase in global FDI in the 1990's. The subsequent dip in FDI was due to world recession in the late 2000. The increase was the end of the downturn in 2005 according to the 2005 world investment report. Eventually the 2007 world investment report states a "global FDI flows approach a 2000 peak high."

The potential costs of FDI for the host country could include:

·         Adverse effects on local competition due to spending power and brand strength of MNC

·         Impact on government decisions due to economic power of MNC thus loss of national autonomy 

·         Environmental Damage

·         Human rights implications

·         Corruption, conflict and other political issues 

With any large business move the benefits and risks must be consider.

A policy of FDI can allow for:

·         Skill and knowledge increase, stemming from new cultures and countries with differing knowledge from the home country.

·         Benefits for employees in host countries - perhaps developing economies that are given the chance to work for the correct wages and have a good standard of living (linking to the need for CSR within organisations)

·         Of course increased profits and tax revenues from profits will sway any company into FDI

·         Credibility in new markets

·         And finally (not by no means the last of the advantages) a chance to re-invest into a local economy.

An example of a multi- national company who are very successful is McDonalds, they originated in America but can now be seen all across the world, and the company is ever expanding. Whereas Greggs in the UK, although began within the same time period as McDonalds, have remained a British company and maintain their success from where they started. If we were to compare these company's in terms of success, profits and exposure, the logical conclusion is McDonald's because of its ventures globally as well as locally.
This is not to say that Greggs are not successful, but could they be more successful if they were to invest globally or even try their hand at Foreign Direct Investment.

FDI is on the increase and therefore it is now, more important than ever that company's consider the investment in order to maintain their competitive advantage.

For Foreign Direct Investment to be seen as successful it needs to be a situation where it benefits both the Multi-National Company and host country.

Stock Market Efficiency

There are three types of stock market efficiency, these are said to be; operational, allocational and pricing.

Operational efficiency relates to the speed, cost and reliability of transactions on the exchange. The market tries to carry out its operations as quick, reliably and as cheaply as possible. In order to do this competition is created between brokers so they can earn only normal profits not excessively high profits.

Allocational efficiency - Firms with the greatest potential to investment funds need a method to channel their funds their way. Stock markets help in allocating resources between competing investments. For example, an efficient market provides vast funds for the growth of the electronics, pharmaceuticals and biotechnology industries but allocates only small amounts to slow growth industries.

Pricing efficiency - the investor can expect to earn merely a risk adjusted return from an investment as prices move instantaneously in an unbiased manner.

In order to see how efficient the market is, there are three different forms of efficiency (Arnold, 2008)

1. Weak form efficiency - This is where the share price reflects all the PAST information, and therefore this past information reflects the price today.

2. Semi-strong form efficency - This focuses on the question of whether it is worthwhile acquiring and analysing publicly available information. This form of efficiency reflects all historic and publicly available information whilst being able to react quickly and rationally to new information

 

3. Strong form efficiency - where the share price reflects all known information, whether that be publicly available or not. This type of efficiency would however suggest that everyone knows everything about the company at any one time, which cannot be the case, as businesses regularly make company announcements that were unexpected to the shareholders and at the same time information can be leaked and cause controversy amongst shareholders as it was not news they were expecting.

On the other hand, stock markets can surprise investors and shareholders regularly which is why they are deemed to be unpredictable and why companies and investors lose and gain vast amount of profits.

This in turn leads on to Kendal (1953) and his Random Walks theory, whereby price changes are completely random based on all information that is known by the shareholders at the time of change, and changes in turn occur when new information enters the market. This thoery seems to me the most reasonable thoery because of the unpredictability of the market and how the shareholders will react.

Raising company capital - Equity vs. Debt

In order for a company to keep expanding it is vitally important for them to raise capital especially in the ever changing competitive business environment. There are two main ways of raising capital for a company and they are either debt or equity. However, it is possible to have a combination of the both in some circumstances.

Equity is where companies issue shares through a number of ways such as ordinary shares, preference shares or deferred ordinary shares. This is a way of attracting shareholders in a goal to get them to invest. Shareholders in turn will consider the rate of return that the company is offering compared to other investments with an equal amount of risk. One advantage of using equity as a source of capital is that the company are not required to pay back the full amount invested or pay back dividends. On the other hand, shareholder activism could result in a loss of shareholders if the return is not satisfactory to the shareholders. Even though the company are under no obligation to return the payment through dividends, in order to satisfy the shareholders it is necessary to compensate them with the satisfactory return.

The Dividend Policy must be considered if equity is being used as a means of raising capital. As discussed in a previous blog, shareholder wealth will be maximised if profits are treated in a certain way to benefit the shareholder, which can only be an advantage to the company. Miller and Modigilani (1958), state that companies must take into account what they issue in the form of dividend which may impact their share price on the stock market, and even more so the impact this change in share price may have on future investors. The Clientele Effect is a result of this because where the share price of a company can move in reaction to a change in policy, in this instance it would be a dividend change, and therefore the use of raising capital through Equity would require constant examination of the company, in relation to shareholder wealth maximisation.

The cost of satisfying these shareholders can be high and can result in a business losing control however maximising shareholder wealth and gaining shareholder funds is a good way to enhance profit and the business, which links to the agency theory problem and managerialism. However, holding managers accountable for their actions can only benefit a company, for example BP have been recently held accountable to their shareholders, through the legal system, due to two oil spillages that occurred in 2006. The voice of the shareholders here is vital to hold the necessary people responsible for their actions that have impacted not only the company and its stakeholders but many others, increasing a company’s awareness of its corporate social responsibility.

Another way to raise capital is by the use debt. In this case lenders have no official control over the business and are unable to vote at meetings which mean they cannot choose the directors or make major strategic decisions. Usually companies cannot last on the stock market at such an early stage in their life but with the funding of debt they can benefit greatly on the stock exchange. Debt has a much lower cost than equity, but still requires repayments to the investor, with interest included as part of the repayment, and these repayments will be required regardless of how the business has performed during the year. Businesses can also use their secured assets to finance their debt, which can cause complications if the business were unable to sustain the repayments on their loans and may even result in losing the business entirely.

Both equity and debt have their advantages and disadvantages in relation to raising capital, however if a business were to use a mixture of both they would not only benefit from increased business exposure and accountability, but will also be able to use finance and repay it without having to worry about a lifelong connection to their investor.


Miller, M. H. & Modigliani, F. (1958). Dividend policy, growth, and the valuation of shares. The Journal Of Business, 34 (4), pp. 411--433.

Stock Markets: The company risk of listing

Stock markets are where the government and the industries businesses can raise long term capital and investors can buy and sell securities. To be listed on the stock market is vital for any business who intends to grow and provide funds for the business and increase the status of the company.

Not only does it help the business continue with its growth, it also makes the business accountable to its stakeholders, thus helping society through systems such as Corporate Social Responsibility (CSR); whilst also allowing benefits to its employees through share reward schemes. Which in turn even makes it easier for shareholders to move between companies if they are unhappy with the business. Listing on the stock market offers liquidity to the investor while encouraging flow of funds to firms.

Such companies like Toyota aimed to enlist its shares on the London and New York stock exchange in order to attract international investors, while meeting the needs of the increasingly global industry and increasing their image. Another reason to enlist globally is to be able to judge whether the company can meet global standards. An example of a company who is enlisted on the London Stock Exchange but their headquarters are in Mexico is Fresnillo. Fresnillo is the world's largest producer of silver from ore (primary silver) and Mexico's second-largest gold miner. The first Mexican firm to have its primary listing on the LSE, they are a constituent of the FTSE 100. The reason they are enlisted on the LSE is because of better liquidity and corporate governance.

However, listing on the stock exchange isn't always great for businesses. As the stock market and share prices are influenced a great deal by the news, share prices are subject to volatile changes if the shareholders are not happy.

Word of mouth can affect the stock market and share price, even if shareholders are happy that the company are making profits and improving, looming talks of the company being unable to keep up with expansion will set back the share price.

The stock market is therefore not always a great place for businesses to be, despite its many advantages to the company, we can see through Twitter that increasing profits are not always enough to satisfy the shareholders and in turn keep the share price level.