Month: August 2015

 

There is a famous cliché that best describes the generational challenge which family owned businesses face: the first generation builds, the second generation consolidates, and the third generation destroys. While family businesses are likely to survive the initial years, sustaining generational growth is a much more difficult feat to achieve.

 

According to the Global Family Business Index, a firm is classified as a family firm where a family controls more than 50% of the voting rights (for private companies) and at least 32% of the voting rights in public companies. In other words, these are companies where the decision making processes are controlled or influenced by a family or multiple generations of a family who may or may not directly manage the firm.

 

The family business model implies some obvious advantages; family ties are assumed to connote greater loyalty to the business. There is also the sense of belonging and comfort in the knowledge of the fact that the success of the business directly benefits each member and their immediate families and family members are more open to making sacrifices for the firm.

 

Blurring the lines between family and business relationships often attracts its own unique challenges, some of them so severe that they culminate in the destruction of the company itself. Several instances of companies separating or liquidating as a consequence of acrimonious family feuds. Other challenges of running a family business include hiring and retaining non-family employees, especially as the perception might arise with respect to an invisible ceiling some family owned businesses place on the career prospects of non family employees.

 

And as if the business, emotional, legal and technical issues weren’t thorny enough, consider this daunting fact: only about 30 per cent of family businesses survive into the second generation. Transition planning and the communication of the results of careful transition planning to stakeholders greatly improves the likelihood that the business will endure well beyond the leadership transition, delivering lasting value to the company.

 

Issues that may arise in the management and transition of family businesses include:

 

1. Situations where one or all of the children develop financial problems or desire to sell their share in the family business for cash: This may be remedied through bespoke individualized powers of attorney or donation contracts including withdrawal rights, whereupon, given certain events such as bankruptcy of a shareholder, the ownership of the shares reverts to the founder or his duly appointed trustee.

 

2. Situations where a founder may desire to restrict or prevent the transfer of shares to unrelated third parties: This may be handled through the insertion of clauses which restrict the transfer of shares to third parties.

 

Milton & Cross has an experienced team dedicated to helping family business owners develop and execute each step in their succession plan in order to ensure the whole process runs as smoothly and efficiently as possible. We invite you to explore how we can help you turn your business challenges into opportunities to create a legacy of success. We may be contacted directly on +2348036258312, or by email on : miltoncrosslexng@gmail.com.

 

In business circles, there is the common saying that ‘Capital is King”. No matter how viable or profitable your business idea or enterprise may be on paper, your prospects are at best, limited without access to a stream of capital sufficient to midwife your idea or concept into reality. Capital is to a business what blood is to the human body and the interruption of its flow implies the cessation of the business or project within a relatively short period and a perennial complaint of business people is inadequate access to capital, high interest rates, and other factors affecting capital issuance.

 

When discussing the ‘printing press’ financiers refer to the practice of a Central bank issuing debt securities for the purpose of financing the activities of a company. In corporate circles however, the printing press refers to the issuance of debt securities by a company for the purpose of financing, irrespective of the intrinsic value of the organization.

 

Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a “last resort”. Hence; internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. Thus, the form of debt a firm chooses can act as a signal of its need for external finance. Companies have an advantage in using debt rather than using internal capital, as they can benefit from debt tax shields. This tax shield allows firms to pay lower tax than they should, when using debt capital instead of using only their own capital. The theory argues that the more debt is issued by the company, the more a firm’s value is created.

 

Asymmetric information (the availability of an informational advantage in favour of a party to a transaction) favours the issue of debt over equity as the issue of debt signals the boards confidence that an investment is profitable and that the current stock price is undervalued (were stock price over-valued, the issue of equity would be favoured). The issue of equity would signal a lack of confidence in the future prospects of the company by the board of Directors and that they feel the share price is over-valued and the Company can make more profit from the sales of equity than they would receive from the issue of debt. An issue of equity would therefore lead to a drop in share price.

 

The savvy CEO who desires to raise financing for his company without encountering the negative effects of equity issuance may ‘print’ cash by issuing debt securities for the purpose of obtaining capital for the prosecution of the projects and activities of the company. However, the value of the debt security thus issued depends upon a substantial number of variables, including the current and projected revenues of the company, micro and macroeconomic factors, and publicly available information relating to the company.

 

Research has focused on the empirical claim that companies face a sharply increased risk of default once their debts exceed certain percentages of revenue, usually 90% of annual revenues. In order for Debt security issues to be viable sources of corporate finance the projected revenues from the investment need to exceed the costs of issuing and servicing the debt. Unfortunately some companies make the error of raising debt to finance deficits in revenue,

The use of Debt securities as a mode of corporate finance implies undertaking the risk for the following occurrences;

1. Costs of Capital: This refers to the effective rate that the company pays on its current debt and includes interest payable on the principal debt sum, costs of obtaining the funds and the opportunity costs of the proportion of revenue applied towards servicing the debt.
2. Insolvency Costs: This includes bankruptcy costs, professional fees for insolvency practitioners and loss of goodwill arising from the insolvency process.
3. Loss of Capital Market Access: In the event that the company defaults in the repayment of the principal or interest of the debt, the company may be restricted or limited from further accessing the capital market. Furthermore, the company may become a pariah in the financial markets, increasing the costs of acquiring further financing.

Milton & Cross provides investment advisory and due diligence services to individual and corporate investors who require legal advice prior to investment in corporate debt securities. We may be contacted directly on +2348036258312, or by email on: miltoncrosslexng@gmail.com