Top stocks to invest in – Investing in Family-Controlled Businesses: Benefits and Risks

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Is the potential value of family-controlled businesses overlooked by investors or are these firms better off ignored?

A panel at the Ben Graham Value Conference IV, hosted by CFA Society New York, discussed this issue and why these firms might be worth investing in.

But much of the crowd disappeared before the panel even began, begging the question of whether such companies have value to offer.

“Looking at the audience, it’s thinned out dramatically,” observed Thomas A. Russo, the managing member of Gardner Russo & Gardner. “Family-controlled businesses . . . are often overlooked.”

And that could spell opportunity.


According to Russo, the mindset of family-controlled companies is long horizon: The principals are concerned with their offspring and other family members, and with securing the business over multiple generations. That long-term mindset can yield more value for investors, he says.

The Promise of Increased Long-Term Yields

But long horizons also require more investor patience.

“So the long-term nature of these, if you can get comfortable with the long-term commitment, makes them very attractive,” said panelist Paul Isaac, CEO and founder of Arbiter Partners Capital Management.

But do family-controlled businesses offer value beyond that of traditional firms?

Recent surveys on family businesses suggest that those who work for them believe they do. PricewaterhouseCoopers (PwC) surveyed senior executives from 2,802 family businesses across 50 countries in 2016. According to PwC, 74% of these executives believe their businesses promote stronger cultures and values than the rest of the market.

When it comes to returns and long-term potential, the PwC survey also found that 55% believe their firms take a longer-horizon approach to decision making compared to other market players.

The Challenge of Generational Change

While there is an argument for better long-term results from family-controlled businesses, the very nature of these firms also poses their biggest potential drawback.

Though a family-controlled firm that has passed through multiple generations may be more likely to outperform, the PwC survey shows that only 12% of first-generation firms make it through to the third generation of management.

Even more troubling, only 43% of the businesses surveyed have a succession plan in place, which might help explain why investors doubt their long-term value.

Increased Agency Costs

The panelists’ final concern was the conflicts that can develop when a family controls a business. A valid question arises: If management must decide between adding value for shareholders or family, might they be inclined to favor the latter?

Family firms often have management in place to help mitigate these concerns. The PwC survey found that 65% of family-controlled firms have nonfamily members on their boards.

Still, the downside of potential nepotism and the associated agency costs remain the main causes for investor skepticism about family-controlled businesses.

Christopher C. Davis, a portfolio manager with Davis Large Cap Value Portfolios, summed up these concerns, observing that family-controlled firms can “become [the] employer of last resort for people with the same last name.”

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Image credit: ©Getty Images/FrankRamspott

 


Robert Del Mauro

Robert Del Mauro is an intern for Enterprising Investor. He currently studies economics as an undergraduate student at Seton Hall University in South Orange, New Jersey.

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