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By Richard M. Segal
January/February 2009
While most have heard of sweat equity, in case you haven’t - it is the hard work you put in theoretically beyond your compensation in hopes of a future reward. Sweat equity is the foundation on which many family firms are built.
Probably fewer of you have heard of patient capital.
Patient Capital
Patient capital is the capital in a business that sits for the long haul and does not seek the quarterly return on investment familiar to most of corporate America.
Seen as one of the greatest strengths of family businesses, patient capital is often left in family firms for generations without there even being a thought of divestiture.
One recent case in point is Dow Jones and Co.
In spite of the company’s outstanding reputation as a publisher of the Wall Street Journal, the returns to the shareholders had been lackluster at best for decades.
The patient capital of the controlling Bancroft family allowed management, editors and journalists to put out one of the country’s institutions with little demand for profit. It wasn’t until one of founder Clarence W. Barron’s 26 great-great grandchildren, Elizabeth Goth, questioned her 700,000 shares as an investment that patience started to run thin.
It seems that Goth wanted to know, at the age of 32, if her fortune of $23 million was as good as it could be.
You probably know the end of the story - the patient capital became impatient and the Bancrofts sold the company to Rupert Murdoch for around $60 a share, almost doubling the value of Goth’s stake.
Patient capital allows long-term strategic thinking. Notice I did not say strategic planning because that is something family businesses are notoriously poor at doing. But thinking about the long term future is different. When a founder begins to dream about children and grandchildren owning the business, then we have to begin some kind of strategic thinking on how to make that happen.
Clearly one way it doesn’t happen is to rape the capital from the company’s coffers. Rather, capital builds without strings attached for decades, or in the Bancroft situation for over a century. It isn’t as much of a strategic plan as it is the family savings account for generations to come.
Sweat Equity
Then there is sweat equity. Hard work, long hours, and “one day this will all be yours.” This is not to say that sweat equity does not exist in non-family business careers, but it is different.
Working long hard hours for your boss might get you a promotion, a raise, a bonus, or a seat at the partner’s table, but it won’t get you the combination to the lock of the patient capital vault like it does in a family firm. Let’s face it, in non-family situations, ownership comes either for cash on the barrel head or by performance based compensation. In most cases, neither applies to a family business - at least not formally.
Ownership transitions get messy with gifting (always with strings attached - even if it isn’t obvious), or through estate plans. Sometimes the estate plans get so elaborate in an effort to beat the tax man that they lose focus of the underlying goal - get the assets to the right place in some sort of timely fashion in order to be of any use. Waiting for death to complete a succession plan seems like a monarchy in disguise.
Collision Course
When the transfers take on a life of their own and lose sight of the goals, the sweat equity gets impatient. Too many times I have seen members of the Next Generation waiting for their turn at the helm only to reach retirement age before they get there.
Sweat equity and patient capital may be strengths of family business, but when they collide conflict erupts. Future generations seek to enjoy the honor, privilege and stewardship of ownership. If they have been in the family business all their lives, where do they get the money to purchase the stock?
Hopefully they have been paid fair market value compensation, but that usually doesn’t give them the assets necessary to buy the business. Their family’s money is tied up in the family’s savings account - the patient capital. Getting that capital out of the company requires some kind of distribution and that reeks of taxes - something many see as intolerable. So there it sits locked in the patient capital vault.
This Might Be the Time
Our current economic situation has driven the value of most businesses down. Lower values makes transfers more affordable. This might be the perfect time to unlock the patient capital and reward the sweat equity.
If you find yourselves in the midst of transition and wondering how to get it done, then you should seek the advice of legal counsel and try to find a way to take advantage of the times. You can have your cake and eat it too by using the patient capital over the long haul to effect a generational transition that works for both generations - and lock the deal in at today’s low rates.
Of course, no transfer is going to work unless the financial security of the senior generation is addressed.
Today’s uncertainty makes retirement funding somewhat of an oxymoron. I would never suggest that the senior generation’s financial stability should be put at risk for the reward of a generational transfer. But, I am strongly suggesting that this is a great time to dust off the succession plans and give them a going over. Let’s hope that your review is better than the way Washington has handled its financial transfers.
Richard Segal is the chair of the Family Business Council, a membership organization of family owned businesses. He can be reached at [email protected].
