For the past generation or so, Dow Jones and Co. has enjoyed a
Jekyll-Hyde reputation as (a) the publisher of a great newspaper-the
Wall Street Journal-and (b) a company with mediocre stock returns.
Both identities sprang from a single source: the hands-off approach of the
controlling Bancroft family-the heirs of publisher Clarence W. Barron-who
left the company's management to good journalists and demanded little
return on their investment
That policy of benign neglect began to change three years ago when one
of Barron's 26 great-great-grandchildren, Elizabeth Goth, discovered that
at age 32 she owned 700,000 shares of Dow Jones stock worth about $23
million and started wondering whether her stake was worth keeping. As one
of her confidants put it, "She woke up and said, 'I care. This is my
fortune. This is my asset. Now what do I do?'" Since then, Dow Jones
managers have been scrambling to boost their stock price to the level of
Like Dow Jones, family firms have long recognized that one of their
main competitive advantages is the stability of their "patient capital."
Family business shareholders used to be willing to wait a long time-in
some cases, like that of the Bancrofts, almost forever-before they
received the dollar benefits of their investment or inheritance. Unlike
publicly traded companies, family firms don't have to dazzle their
shareholders with next-quarter earnings.
Or so the theory goes. Unfortunately for family businesses today, the
stability of "patient capital" is often being shaken at its roots-among
the family shareholders themselves.
As a result of the unprecedented wealth build-up of the last ten years,
many shareholders in family businesses have accumulated wealth outside the
family business. What's more, the passage of generations as well as
today's desire for short-term rewards have reduced what's known as "the
Family Effect": the combined value of a family firm's ownership, heritage
and stewardship. "What have you done for me lately?" is becoming the most
commonly heard question at family business shareholder meetings.
But all is not lost. You can regenerate or even enhance the "patience"
in patient capital by focusing on one very simple concept: increasing
In a publicly traded company, shareholder value is easily measured: The
higher the stock price, the more money shareholders make when selling
In a family company, in which a limited market exists for the stock
owned by the family, shareholder value is measured in the form of excess
cash return-that is, the cash returns generated by the business after cash
expenses, taxes and investments above the cost of capital. This excess can
be distributed to shareholders, reinvested in the business or put to other
By creating shareholder value, the company assures shareholders that
their return expectations are met-and, consequently, they'll be more
inclined to keep their investment in the family firm instead of seeking
greater returns outside or clamoring for the sale of the company.
The cost of patient capital
Does it come as a surprise that family shareholders harbor expectations
for their investment-in other words, that patient capital has a cost? It
shouldn't. Yet too many business owners take family money as a given and
believe it costs the business nothing. The question is how to define the
cost of patient capital. There are several ways to do it.
- The opportunity of cost. This is the rate of return that
family shareholders could earn on their money if they took it out of the
family company and invested it elsewhere. If they know they can get a
12% annual return by investing it in the stock of comparable publicly
traded companies, for example, that's the starting point of their
expectations. And if your company is returning 8% or 10%-well, already
it's not looking so good by comparison.
- The degree of liquidity. When family members buy publicly
traded shares, they can sell them any time they wish. But since most
family business investments are not marketable, family shareholders
expect a premium to compensate for that lack of liquidity. If the return
on an outside investment is 12%, family shareholders might want that
plus an extra percentage point or two for keeping their funds in the
family firm, putting your cost of capital at 13% or 14% or more. But if
your company has a liqidity program and family shareholders can redeem
shares with some ease, their expectations will be lower.
- The "family effect." This phrase takes into account the
intangible return of being a part owner of a family business, such as
the commitment to the family heritage, the stewardship of wealth and its
values to one's children, or just the satisfaction of being part of a
When the family effect is strong, family shareholders tend to demand
less financial return. The shareholders who were thinking in terms of 13%
might now reduce their expectations-as well as your cost of patient
capital-to, say, 11%.
Take aggressive steps
When your cost of capital exceeds the cash return generated by the
company, you need to manage aggressively on behalf of shareholder
value-increasing your cash return above the cost of capital or reducing
the cost of capital, or both.
Consider the case of Tops Pet Food (not its real name), a family-owned
business with more than 40 family shareholders. Only three of them work as
senior executives in the family business. Most of the other shareholders
have built significant outside wealth. So the family managers of Tops
shouldn't have been surprised when, at last year's annual meeting, several
shareholders raised questions about the value of their Tops shares. Some
even suggested that they might be better off selling their shares in Tops
and investing the proceeds elsewhere.
Confronted with shareholder dissatisfaction, Tops Pet Food's family
managers first surveyed their shareholders to determine the strength of
the family effect. They also ascertained what returns family members could
expect if they put their money into publicly traded companies in the same
This fact-finding showed Tops that its cost of patient capital-what the
family shareholders expected returns to be-was about 16%. The business,
however, generated only about 11%. The disparity meant there was a high
risk that family shareholders sooner or later would say, "We can do much
better on the outside, so we want to sell the company."
To head off that possibility, the managers launched liquidity programs
for the shareholders and took steps to strengthen the family
effect-introducing a family newsletter, a family website and a shareholder
education program. As a result, family shareholders lowered their return
expectations, thus reducing the company's cost of capital.
To increase the company's cash return, Tops sold off some
underperforming divisions, introduced incentives to increase productivity,
renegotiated some of its bank credit lines and initiated a major
As family shareholders saw management swing into action, they became
very supportive. And their faith has been richly rewarded: The company's
cost of capital is now down to about 10.5%, while the company's cash
return has risen to more than 16%. Needless to add, the shareholders are
But increasing shareholder value produces more than shareholder
happiness and loyalty. As the Tops example shows, it strengthens the
family and the business to survive the demands of the present and the
challenges of the future.