I have followed the story of CMC’s change of management and leadership with great interest. Every family business grapples with the issue of managing shareholders. (READ: Shareholder war puts CMC under regulator’s radar) The primary fear, especially among family business founders, is the loss of control to outsiders who do not subscribe to the founders’ values.
What is happening at CMC, good or bad, epitomises what could happen when original shareholders gradually lose control to newcomers. Peter Muthoka of Andy Forwarders has, over a few years, acquired 132 million shares in CMC (worth Sh 1.782 billion at last week’s price of Sh13.50 per share) to become the largest single shareholder. That in itself is not wrong — it’s a free market.
However, over the past 17 years Andy Forwarders has also grown into one of CMC’s biggest customers for trucks and prime movers in addition to being the firm’s top supplier of goods and services, collecting Sh1.17 billion from CMC in 2010. How the board (comprising the who is who of Kenya’s corporate governance) allowed an individual with whom the firm does the most business to ascend to the chair is intriguing.
If we are to believe the new CEO Bill Lay, Andy Forwarders has (allegedly) consistently over invoiced CMC by between 10 and 30 per cent, a plausible argument based on the fact that he has operated in the auto business and used the same logistics services for which his previous employer paid significantly less than CMC reportedly paid Andy Forwarders. If this allegation is true, CMC overpaid Andy Forwarders Sh351 million last year alone. Multiply that by five years and you have Sh1.755 billion; roughly what one needs to buy a 22.6 per cent stake in CMC. Take this logic to its extreme and you have CMC buying a sizeable chunk of its stock with its own money and giving it away to someone else.
This scenario is not new. Ted Turner (of the CNN Time Warner fame) did the same thing in 1976 when he acquired the Atlanta Braves — with their own money. The deal went something like this.
The Atlanta Braves were making losses of a million dollars a year. Their owners wanted to sell the club for $10 million, money which Ted Turner did not have. Ted Turner offered them a million dollars down payment with the rest spread over eight years. Because Ted Turner was already paying US$600,000 for Atlanta Braves broadcasting rights, all he had to do was continue to pay for these rights with an additional US$600,000 over the next eight years after, which he acquired the rights and the team itself. It also turns out that after auditing the team’s books of accounts, Ted Turner discovered $1 million that the previous owners did not even know they had. All said and done. He acquired the team at no risk, for a pittance.
Family businesses, especially those whose real value lies in latent assets such as land, unique market linkages, proprietary products or information acquired or developed over long periods of time are at particular risk of acquisition on less than fair terms.
The main reason is that the family members, by virtue of their day to day interaction with these assets, do not see the value they hold in their hands. Even worse, members of the generation succeeding the founder may be easily convinced that the assets are nearly worthless and that the purchaser is their only source of salvation. We are now in the age of 50:50 deals in which a family business contributes 50 per cent by putting their land, proprietary products or valuable information in exchange for 50 per cent brought in by the investor, very often by borrowing from banks using the family’s assets.
As family businesses look outside for investors, they must exercise due care, conduct detailed market research and get proper valuations of the assets they have in hand. In order to ensure objectivity, the owners must involve competent professionals who have no vested interest.
As the family business owners court (or are courted by) various potential investors they should use the following criteria to decide on the way forward.
First, do the family members intend to stay in the business in the short or long-term? Do they understand the true value of their property? If they are selling the business they must consider the welfare of long-serving staff and ensure they are taken care of in the sale agreement.
Second, should the family decide that they want to continue operating the business, do the new investors subscribe to their core values? If not, to what extent are there differences in values? A family business with service to community as a core value would be unwise to partner with an investor whose interest is pure profit.
Finally, what value does the investor bring to the table? Whose cash are they using? Can the family business raise money from the same sources? What expertise, connections or networks do they have? How long are they likely to be involved in the business?
Honest answers to these questions will lead the family business to make prudent decisions as to whether to invite investors into their business, who these investors should be and how they will be managed.