Post by oldman on Nov 11, 2013 5:57:51 GMT 7
Your First Million, 2nd Edition
Chapter 2: The Players
Generally, there are three types of shareholders:
1. Controlling shareholder
This shareholder has over 50% of the issued share capital and hence, he usually has the final say on how the company is to be run. In many ways, he is in such an enviable position that he can even be seen as ‘owning’ the company 100%. Yes, investors may have placed money in his company but the controlling shareholder still has the final say. (I am assuming that there is only one class of shares.)
2. Substantial shareholder
This shareholder owns a significant percentage of the company but his ownership is not above 50%. Hence, in theory, he is not in total control of the company, unlike the position of a controlling shareholder.
3. Minority shareholder
Most of us fall into this category. We own just a few thousand shares. Some, may of course own millions of shares but as a percentage of the total shares in issue, we each have a very small percentage.
The truth is that minority shareholders have very minor rights. Their rights may simply be the right to be heard and to ask questions during an AGM (Annual General Meeting) or EGM (Extraordinary General Meeting).
For minority shareholders, it is also good for us to understand the majority shareholder’s perspective first. The majority shareholder is usually the one who has sunk in the most money or effort to build up the company. He should have most at stake and, theoretically, his interests should be aligned with all other shareholders.
But of course, the real world is a lot more complex than that. There may be relationships or business arrangements with other companies that he also owns or he may take the longer-term view instead of the short-term view of many minority shareholders.
The reason why the main shareholder likes to have more than 50% is because he can have the last say in most decisions, if he were to exert his rights. Minority shareholders can air their points of view but the majority shareholder is usually the one making the final decision.
Of course, if the company were listed, there are additional pressures for the management (who are usually the majority shareholders as well) to hear the viewpoints of minority shareholders and answer their questions during an AGM or EGM. However, the majority shareholders usually make the final decision on any matter. After all, what’s the point of owning more than 50% if you cannot have the final say?
It is always better to be a significant shareholder than just a minority shareholder. A significant shareholder is a minority shareholder whose name usually appears in the top 20 of the shareholder list. Significant share-holders who own less than 5% of the shares and are not related to the directors of the company, need not formally declare their interests. Fund managers are usually in this category. Being a significant shareholder, they can contact the management if they desire and usually, the management will make time for them.
Life, you see, is never fair. All minority shareholders should aspire to become significant shareholders. For the smaller companies, this is not that difficult – just that the investors have to learn to have a concentrated portfolio.
If it comes to the crunch for majority shareholders who are also managers, they would of course protect their interests first. Minority shareholders are transient passengers who really want to make money from the market. And if the company is not doing well, they can easily bail out by selling their shares. Majority shareholders who are owners don’t have the luxury of doing so. They have to continue fighting to save the company.
It is therefore not fair to think that one can force majority shareholders to listen completely to what minority shareholders want. But it is fair to say that, in general, most minority shareholders are after short-term gains, which may not be in the long-term interests of the company.
Yes, as a public company, it is a matter of give and take. But, as minority shareholders, one cannot have the entire cake and eat it. One has to understand the position of the management/majority shareholders as well.
On the surface, management and shareholders appear to have the same objective, which is to build up the company. In reality, though objectives are usually aligned at a high level, at an operating level the following potential conflicts of interest, among others, may arise:
1. It is in the management’s interest to maintain as much cash in thecompany as possible. With a cash hoard, the management could acquire other companies, thereby increasing its revenues and profits, and reducing dependency on its core business. Their jobs would be more secure with an increase in revenues and size of company.
Shareholders, on the other hand, may want regular dividends so that they can diversify their investments. And I am sure shareholders also like the feeling of receiving a return every year for their investments.
2. Management would want to receive high salaries, especially if they do not own significant stakes in the company. But for shareholders, if the management’s salaries are low, then profits will be higher. With greater profits, the PE (price-earnings) will also be higher and hence, the share price is more likely to rise.
If the management are also significant shareholders, they may decide to take a salary lower than the industry norm, as every reduction of, say, $100,000 in expenses can result in an increase in earnings by the same amount. If the company has a PE of 10, this can result in an increase in market capitalisation of $1 million. If the management own 50% of the shares and they forgo the $100,000 hike in annual salaries, their net worth would increase by $500,000.
However, as the company grows in size, this issue may not be that relevant, as a $100,000 reduction in expenses to a company with a profit of $10 million is not that significant.
3. Shareholders are investors and if another company wants to buy over their company at a fair value, they may want to consider the offer very seriously. However, management is more likely to be cautious, as they may not be able to maintain their jobs, especially if the other company is a competitor that wishes to consolidate the market and save on overlapping costs.
For shareholders, management who are also substantial shareholders are probably the best types of managers to have, as they are more likely to consider both their own interests as well as the interests of the company.
However, management too are human and, depending on the size of their stakes in the company, they may act in a manner to protect their own interests first.
Hence, it is logical to split the roles of chairman and CEO, so that the CEO looks after the interests of the management and the chairman looks after the interests of the shareholders.
With smaller companies especially, one has to ensure that the objectives of the management (who are usually the controlling shareholders as well) are in line with those of minority shareholders. Some of these companies keep a very low profile and management rarely gives updates to the minority shareholders. In AGMs (Annual General Meetings), these companies do not take too well to feedback from minority shareholders.
Also, one has to be wary if the company does a lot of transactions with related companies. Some of these companies may be co-owned by the majority shareholder. This makes it difficult to gauge the actual profitability of the business as one can buy from a related company at a higher price or at a lower price, depending on what the majority shareholder wants to achieve.
Similarly, I am extra careful if the daughter company is listed rather than the holding company. For example, if the holding company owns a manufacturing plant, it can theoretically lower the manufacturing price to make the daughter company look very profitable. The manufacturing company, on the other hand, will chalk up huge losses. But as this is unlisted, few will know or care.
Chapter 2: The Players
Generally, there are three types of shareholders:
1. Controlling shareholder
This shareholder has over 50% of the issued share capital and hence, he usually has the final say on how the company is to be run. In many ways, he is in such an enviable position that he can even be seen as ‘owning’ the company 100%. Yes, investors may have placed money in his company but the controlling shareholder still has the final say. (I am assuming that there is only one class of shares.)
2. Substantial shareholder
This shareholder owns a significant percentage of the company but his ownership is not above 50%. Hence, in theory, he is not in total control of the company, unlike the position of a controlling shareholder.
3. Minority shareholder
Most of us fall into this category. We own just a few thousand shares. Some, may of course own millions of shares but as a percentage of the total shares in issue, we each have a very small percentage.
The truth is that minority shareholders have very minor rights. Their rights may simply be the right to be heard and to ask questions during an AGM (Annual General Meeting) or EGM (Extraordinary General Meeting).
For minority shareholders, it is also good for us to understand the majority shareholder’s perspective first. The majority shareholder is usually the one who has sunk in the most money or effort to build up the company. He should have most at stake and, theoretically, his interests should be aligned with all other shareholders.
But of course, the real world is a lot more complex than that. There may be relationships or business arrangements with other companies that he also owns or he may take the longer-term view instead of the short-term view of many minority shareholders.
The reason why the main shareholder likes to have more than 50% is because he can have the last say in most decisions, if he were to exert his rights. Minority shareholders can air their points of view but the majority shareholder is usually the one making the final decision.
Of course, if the company were listed, there are additional pressures for the management (who are usually the majority shareholders as well) to hear the viewpoints of minority shareholders and answer their questions during an AGM or EGM. However, the majority shareholders usually make the final decision on any matter. After all, what’s the point of owning more than 50% if you cannot have the final say?
It is always better to be a significant shareholder than just a minority shareholder. A significant shareholder is a minority shareholder whose name usually appears in the top 20 of the shareholder list. Significant share-holders who own less than 5% of the shares and are not related to the directors of the company, need not formally declare their interests. Fund managers are usually in this category. Being a significant shareholder, they can contact the management if they desire and usually, the management will make time for them.
Life, you see, is never fair. All minority shareholders should aspire to become significant shareholders. For the smaller companies, this is not that difficult – just that the investors have to learn to have a concentrated portfolio.
If it comes to the crunch for majority shareholders who are also managers, they would of course protect their interests first. Minority shareholders are transient passengers who really want to make money from the market. And if the company is not doing well, they can easily bail out by selling their shares. Majority shareholders who are owners don’t have the luxury of doing so. They have to continue fighting to save the company.
It is therefore not fair to think that one can force majority shareholders to listen completely to what minority shareholders want. But it is fair to say that, in general, most minority shareholders are after short-term gains, which may not be in the long-term interests of the company.
Yes, as a public company, it is a matter of give and take. But, as minority shareholders, one cannot have the entire cake and eat it. One has to understand the position of the management/majority shareholders as well.
On the surface, management and shareholders appear to have the same objective, which is to build up the company. In reality, though objectives are usually aligned at a high level, at an operating level the following potential conflicts of interest, among others, may arise:
1. It is in the management’s interest to maintain as much cash in thecompany as possible. With a cash hoard, the management could acquire other companies, thereby increasing its revenues and profits, and reducing dependency on its core business. Their jobs would be more secure with an increase in revenues and size of company.
Shareholders, on the other hand, may want regular dividends so that they can diversify their investments. And I am sure shareholders also like the feeling of receiving a return every year for their investments.
2. Management would want to receive high salaries, especially if they do not own significant stakes in the company. But for shareholders, if the management’s salaries are low, then profits will be higher. With greater profits, the PE (price-earnings) will also be higher and hence, the share price is more likely to rise.
If the management are also significant shareholders, they may decide to take a salary lower than the industry norm, as every reduction of, say, $100,000 in expenses can result in an increase in earnings by the same amount. If the company has a PE of 10, this can result in an increase in market capitalisation of $1 million. If the management own 50% of the shares and they forgo the $100,000 hike in annual salaries, their net worth would increase by $500,000.
However, as the company grows in size, this issue may not be that relevant, as a $100,000 reduction in expenses to a company with a profit of $10 million is not that significant.
3. Shareholders are investors and if another company wants to buy over their company at a fair value, they may want to consider the offer very seriously. However, management is more likely to be cautious, as they may not be able to maintain their jobs, especially if the other company is a competitor that wishes to consolidate the market and save on overlapping costs.
For shareholders, management who are also substantial shareholders are probably the best types of managers to have, as they are more likely to consider both their own interests as well as the interests of the company.
However, management too are human and, depending on the size of their stakes in the company, they may act in a manner to protect their own interests first.
Hence, it is logical to split the roles of chairman and CEO, so that the CEO looks after the interests of the management and the chairman looks after the interests of the shareholders.
With smaller companies especially, one has to ensure that the objectives of the management (who are usually the controlling shareholders as well) are in line with those of minority shareholders. Some of these companies keep a very low profile and management rarely gives updates to the minority shareholders. In AGMs (Annual General Meetings), these companies do not take too well to feedback from minority shareholders.
Also, one has to be wary if the company does a lot of transactions with related companies. Some of these companies may be co-owned by the majority shareholder. This makes it difficult to gauge the actual profitability of the business as one can buy from a related company at a higher price or at a lower price, depending on what the majority shareholder wants to achieve.
Similarly, I am extra careful if the daughter company is listed rather than the holding company. For example, if the holding company owns a manufacturing plant, it can theoretically lower the manufacturing price to make the daughter company look very profitable. The manufacturing company, on the other hand, will chalk up huge losses. But as this is unlisted, few will know or care.