When a competitor submitted a takeover bid five years ago for Taubman Centers, the huge Michigan-based shopping mall developer, the Taubman family did what controlling families usually do in such cases: They reorganized the company’s ownership structure, increasing the family’s stake from 19% to 30% of the voting shares—enough to block any future hostile takeover bids.
Sure enough, five years later, a dissident group of non-family minority shareholders, Simon Property Group of Indianapolis, has offered $1.74 billion for the company, which the Taubman family and the company’s independent directors rebuffed. Simon countered by challenging the legality of the 1998 reorganization—claiming, among other things, that the Taubman family pushed through the reorganization without proper disclosure and without a shareholder vote.
The legality of that 1998 Taubman restructuring is still being appealed back and forth as of this writing. But suppose the dissident shareholders had been related to the Taubmans. Instead of protecting the company’s management, such a reorganization might have devastated the controlling family.
That’s just what happened to another family business I know. This food company, owned by 30 members of the third generation, was paralyzed by 15 dissenting inactive family shareholders who kept voting down family managers’ attempts to re-invest capital in improvements and expansion opportunities. The dissidents wanted the company to pay higher dividends—a common demand among inactive shareholders.
The ten active managers created a voting trust, into which they placed all of their shares plus those of five other inactives who supported them. Two trustees—family managers, of course—vote this entire bloc. This arrangement enables them to make decisions quickly and take advantage of business opportunities as they arise.
In the seven years since the third generation created this voting trust, the company has become much more profitable as it maneuvers in its market more freely. And that has created more value for all shareholders. But the family has paid a steep price: The 15 inactives are angrier than ever, thanks to the high-handed way they were deprived of their voice in company decisions. The family factions are now entangled in lawsuits that may jeopardize the long-term survival of the family company.
Voting trusts have been much more common in Europe than in the U.S., where SEC regulations make it tough to take that route. However, such trusts are legal and are beginning to get a toehold in some U.S. family companies. Voting trusts do a great job of addressing one side of the family business triangle (see diagram)—capital to grow and create value. But in many cases, voting trusts fail to address, and may even exacerbate, the other two sides of the triangle: the liquidity and control needs of shareholders.
Are there any solutions to a family squabble besides this “radical dissident-bypass surgery”? Each family situation is different, and there’s no such thing as a free lunch. But in today’s capital-market environment, here are some alternatives to voting trusts that may address some or all of these needs:
• Recapitalize the business by creating another class of stock, such as non-voting preferred stock. The tradeoff: The preferred shares would pay a higher dividend, which addresses liquidity concerns of inactive shareholders but obviously costs the company money and leaves less capital for growth or maintenance.
• Convert to a limited liability corporation (LLC). This structure allows the company to have different classes of members with different powers and dividend yields on their classes of stock. Tradeoffs: As with granting preferred stock, the management class gets more control over day-to-day and strategic opera tions, but the company must shell out higher cash returns to shareholders.
• Spin off or split the business. Tradeoffs: While this tactic would allow each of the shareholder groups to control their own destiny and future liquidity events, it does raise a question about the ability of the individual units to raise capital to grow. The valuation of each of the units would be an issue as well.
• Have the pro-growth family managers buy out the inactive family shareholders. Tradeoffs: Finding a fair and reasonable price that responds to the liquidity needs of active and inactive shareholders may be difficult. Financing a buyout might hamper future business growth or unduly erode the company’s debt-equity ratio. Therefore, a buyout often requires an outside private-equity investor or strategic partner, whose arrival can create a whole new group of relationship issues.
• Sell the entire business and distribute the proceeds according to ownership. Tradeoffs: This is a drastic solution that addresses liquidity needs of shareholders and control (because they now have their money). It may also be difficult to find a buyer that all family members find acceptable.
Dissension among family shareholders is almost unavoidable, especially as the company expands and the family moves into the third and fourth generations. But the value of a family’s “patient capital” in today’s uncertain world has an even greater impact on the ability of the business to take a long-term, strategic approach to decision-making.
In other words, it’s short-sighted for active shareholders to view inactive shareholders’ needs as bothersome constraints. Those who take a positive view—who nurture their family’s and company’s patient capital, by addressing all shareholders’ liquidity and control needs—give their company the best chance to grow and prosper in the future.