Public company status has proved highly unsatisfactory for many of Britain's entrepreneurs. Is it better for business to stay private?
In an intrusive modern world, privacy is a luxury afforded only to those who are extremely rich or extremely cautious. The same can be said in business: the norm in the development of most go-ahead companies is to go public at the earliest opportunity. A stock-market listing is a rite of passage equivalent to a socialite's first photo-spread in Hello!.
But - just as in high society - the advantages of privacy tend to be forgotten in the rush for recognition. It is instructive to remember those high profile entrepreneurs who have rued the decision to abandon private control of their businesses, and decided belatedly to reverse it. Anita Roddick, founder and chief executive of the Body Shop cosmetics chain, is the latest of them.
Roddick's problem is that she hates dealing with the City. 'Pin-striped dinosaurs' is one of Roddick's more polite descriptions of the City men who irritate her so much. 'Finance bores the pants off me,' she says. Body Shop has multiplied in value many times since its 1984 flotation but it has never established a comfortable relationship with its institutional investors and analysts.
Slighting remarks about the company's ethical standards and about Roddick's own heart-on-the sleeve social conscience have provoked her to fury, in one case followed by a successful libel action. For the steward of a public company to spend time and resources campaigning for the rights of remote tribes people is, in the conventional City view, an unbusinesslike self-indulgence.
Body Shop's share price fell sharply after profit warnings in 1992 and then again in May 1995, when investors apparently rejected the explanation that a pause for 'reflection and reinvention' was required. To Roddick, this was conclusive evidence of the City's chronic 'short-termism'.
Was she right? Does flotation force a company to lose sight of its long-term fundamentals in the interest of keeping ignorant punters happy? There is, it seems, a kind of Faustian pact involved, in which access to new capital and personal liquidity is gained at the expense of management freedom. Proponents of the stock market argue that its implied restrictions on management behaviour are a positive benefit to most companies, in terms of discipline and measurement of performance. Proponents of staying private reply that because the market fails to understand, beyond a superficial level, what makes entrepreneur-driven companies tick, it often sends them the wrong signals; and that for the entrepreneurs themselves there is an organic link between ownership and creativity which loses its strength when ownership passes to a wider group.
A case can be made that direct ownership imposes a different, and ultimately more valuable, set of disciplines on managers, which are lost when a company goes public. Private companies have to find growth through their own cash-flow or borrowing. This focuses attention on which opportunities will generate decent returns on the cash invested. There is no need to increase short-term profits to underpin share prices; there is no distracting temptation to make acquisitions which will automatically enhance earnings per share, regardless of the underlying return on capital. Value in private companies may be less measurable from day to day, but is likely to be more solid in the long run than the house-of-cards value of empire-building stock-market players.
For too many companies, a stock-market quotation has been taken as the green light to go for growth for its own sake - or possibly to enable substantial directors' rewards to become insignificant when part of a far larger whole. Stock markets are littered with companies which witnessed explosive growth while doing a very poor job in gaining decent returns on the capital they invested. Some companies have been found out when the absence of cash generation, masked by seemingly continual share issues, became painfully obvious. Other companies find themselves finally marooned by a combination of a low share price and a collection of acquired businesses which have never been managed with an eye to enhancing shareholder value.
But for every go-go goner, there are sensibly managed businesses which have used the stock market's capital carefully. Almost all of Britain's largest and most respected businesses are quoted, in large part due to the need at certain stages of their development to raise capital to grow the business. Certain of Britain's most dynamic entrepreneurs, however, perceive the price of being a public company as far too high.
Richard Branson is a case in point. When the music publishing and retailing side of his Virgin group went public in 1986, 100,000 small investors subscribed for the issue but City institutions shunned it, regarding Branson, the bearded balloonist and practical joker, with quizzical suspicion. Since the music business represented a tiny segment of the stock market (there were only two comparable companies), few fund managers took the trouble to understand what made it tick. Branson rapidly tired of making presentations to men in suits who had never heard of the rock bands on Virgin's list, and resented the restrictions imposed on his own time when he was trying to press on with the development of his airline, among many other private projects. The share price drifted below its 140p issue price, falling after the 1987 stock-market crash to 83p.
This led to 'Project Experience', Branson's secret plan to go private again. At Virgin's February 1988 board meeting the key issues were aired - and they form a checklist for any private company contemplating - or regretting - flotation: going public had allowed Virgin to use its own equity to buy other businesses, and potential deals had become easier to attract; it had given the founders a way of taking money out; Virgin's public status allowed it to borrow more easily and at lower rates of interest. It could attract better management. It was being run in a more disciplined way. And in any case, as one director pointed out, flotation was not meant to be a fair-weather exercise but a permanent development which would naturally take time to shake down.
On the other hand, complying with public company rules and keeping shareholders informed were expensive, time-consuming activities. Since Branson and his founding partners did not want to lose control, the quantity of new paper which could be issued in acquisitions was in practice strictly limited. The shares floated were now largely in institutional hands but there was still a lack of understanding which led to pressure for short-term profit performance above all else.
The decision reached was that the shares should be bought back at the original issue price, which had valued the company at £240 million. Less than four years later, Branson sold part of it, the music division, to Thorn-EMI for £510 million, crystallising his position as (according to the Sunday Times) one of Britain's 10 wealthiest citizens.
History provides at least two more vivid examples of tycoons who considered themselves misunderstood, retreated into privacy and multiplied their wealth as a result. The composer and impresario Andrew Lloyd-Webber floated his Really Useful Group in 1986 and took it private again in 1990, the market having shown scant sympathy for the risks involved in theatrical promotion. But as Lloyd-Webber's Cats has become, by some distance, the biggest box-office money-spinner of all time, he can draw plenty of satisfaction from his decision to buy off doubting shareholders.
Even more illuminating is the tale of Sir James Goldsmith, nowadays best known for his trenchant views on European politics, but in the 1960s and '70s the architect of the world's third-largest food retailing group, of which the British arm was Cavenham Foods. Goldsmith built up Cavenham in 13 years of relentlessly aggressive takeover activity - beginning with very limited capital of his own, and taking full advantage of the stock-market route to growth for as long as it suited him to do so.
Wary of his gambler's reputation and unorthodox private life, however, the City never warmed to him. Goldsmith in turn resented coming under the scrutiny of the financial press and declared that 'only a fool or a masochist' would want to be chairman of a British public company. In 1977 he used his French master company, Generale Occidentale, to bid for all the publicly held shares of Cavenham. This, he later explained 'made me richer than I ever dreamed of, because by going private at the bottom of the market and buying my shares when they were cheap, meant that instead of having a huge empire in which I had only a percentage, I ended up owning the whole thing'.
There are other names to conjure with who must regret that their luck was not as good as Goldsmith's. Alan Sugar, founder of Amstrad, had his dislike of the City cruelly confirmed when it rejected his 1992 offer to take his company private again. George Walker - always convinced that financiers looked down on him - took Brent Walker private in 1982 when its property-dealing profits collapsed, but went public a second time in 1985 with an expansionist strategy which the City backed to the hilt, and which eventually ruined him.
Roddick, Goldsmith, Branson, Sugar ... the list so far is a rollcall of some (indeed almost all) of the idiosyncratic and mercurial business leaders of the past two decades. Little wonder, perhaps, that what they had in common was a temperamental inability to submit themselves to the tiresome routines and restraints of public company stewardship: this says at least as much about the characteristics of creative entrepreneurship as it does about the stuffiness and perceived short-termism of the financial community.
And what of that accusation? The London Stock Exchange offers a highly efficient mechanism for moving and raising capital, and a very large number of companies had taken advantage of that facility in recent years - no less than 739 names between 1990 and 1994. 'The decision to go public is a major landmark in a company's development ... a prestigious yet challenging undertaking which can generate substantial capital ...' proclaims the glossy brochure of the London Stock Exchange. In 1994 alone, there were 256 new entrants, and £11.5 billion of capital was raised, excluding privatisation deals. The stock market does what it does extremely well: can we criticise it on the basis of the antics of a handful of mavericks who might have been better advised to steer clear in the first place?
Yes we can, says Will Hutton, economics editor of the Guardian and author of The State We're In, a passionate critique of, among other things, the modern British financial system, which he believes fails to encourage productive investment and social progress. According to Hutton, the market's 'restless daily adjustment of prices' may be an efficient way of identifying relative value between one company and another, but it is a deterrent to long-term investment both because it tends to make new equity capital very expensive and because it undervalues earnings while over-rewarding near-term profits and high levels of dividends.
Academic research, by David Miles in the Economic Journal, backs up Hutton's argument: profits expected in five years' time, according to Miles, are undervalued by the stock market by up to 40%. Cash flows more than five years in the future are discounted at twice the rate of shorter term flows - a finding which confirms the observations of Boots finance director David Thompson, who talked to Management Today in September 1995 about Boots belief in long-term cash flow as the key to shareholder value. 'Our timetables are a lot longer than the stock market's,' he observed.
These trends which Hutton dislikes are particularly prevalent, he says, at times of heightened takeover activity, when frightened companies are overwhelmingly concerned to pander to the short-termist tastes of the stock market. The liquidity of the market, meanwhile, encourages lack of commitment among would-be owner-managers, who are the people most likely to take a balanced long-term view of the company's interests. All of this is 'at the heart of the British economic malaise'.
Similarly, two more academics, Charles Hampden-Turner and Fons Trompenaars in Seven Cultures of Capitalism, take another swipe at the British obsession with stock-market dealing as a substitute for what they consider to be positive productive models of corporate development: their section on the activities of Lord Hanson and his late partner Lord While is headed 'Lords of Decline' and their summary of the Hanson strategy concludes: 'It reads like a catalogue of Britain's ills'.
So there is sober economic and corporate criticism of stock-market mechanisms to be added to the jibes of irritated tycoons. Comparison is often made with Germany's mittelstand, the layer of middle-sized, often family-run, businesses which form the backbone of German manufacturing strength. The Frankfurt stock exchange remains a modest, unsophisticated bourse by comparison with London, because the German financial system is geared to providing long-term capital for industry, rather than taking on a life of its own in which companies become pawns in a frenetic game of securities trading.
Many German companies, though listed on an exchange, have relatively small numbers of shares which are actively traded, the rest being closely held by family owners or committed long-term institutional investors, including major banks. In British terms, they are therefore able to behave like private companies and, it might be argued, the difference in results has been plain to see over the past 25 years. Similarly, throughout Asia the fastest-growing manufacturing companies tend to be family-dominated and run as private fiefdoms even though their shares may be listed. Shrewd investors in that region tend to place their faith in the theory that what is good for dominant family owner-managers is likely to be good for the company as a whole, and therefore for outside shareholders, in the long run.
In Britain, this fertile mixture of private and public ownership of companies rarely persists. But the more positive features of owner-managership are confirmed by the continuing success of some of our own most notable private business empires - the Bamford family in construction and earth-moving equipment, the Swires in trading, transport and property, the British Rothschilds in banking and investment, the Baxter clan on Speyside in soups and jams, and some of their neighbours in the whisky distilling industry.
There is, however, a dose of special pleading in this persuasive line of argument. Going to the stock market may present all the pitfalls and frustrations identified here, but it is still for many companies the best (and for some the only) choice available for the continuing growth and development of the business. Staying private may be a luxury the company simply cannot afford.
David Simpson is a corporate finance director of BZW, the investment bank whose job is to advise directors and owners of British companies on the pros and cons of flotation. 'I have to tell owner-managers that being listed is going to make it more difficult for them to sell, in one sense, because the stock market is very sensitive to executive directors reducing their holdings in the businesses they run. And I have to tell them that they now have two essential functions rather than just one: they still have to manage the fundamentals of the business properly, but now they also have to articulate their strategy clearly and persuasively to the market as well'.
David Codling, chief executive of Hozelock, the Aylesbury-based garden equipment maker was brought to the market by BZW in November 1993 with a capitalisation of £60 million. Hozelock was a management buyout backed by venture capitalists so the chances of remaining private and independent were slim. But Codling's view on the question of the short-termism of stock-market investors is particularly telling: 'Everything's relative to the position you started from, isn't it? As a subsidiary of a bigger group in the old days, we had no access to cash for expansion. As an MBO, our balance sheet was too weak to raise money. In our case the most important effect of flotation is that it has enabled us to take a much longer term view of the business,' says Codling.
So in the end it is a matter of horses for courses. For the autocratic entrepreneur who is still in full vigour, the attractions of being able to use other people's money, through the stock market, to fund bold ideas to which private resources will not quite stretch, has to be weighed against all the tiresome distractions expected of a well-run public company.
There will have to be a restructured board, fulfilling Cadbury guidelines, and something called 'succession planning'. There will be press scrutiny of the chairman's remuneration package, and criticism of lesser family members who retain their jobs in the business. There will be endless meetings with analysts and fund managers, who will never quite grasp the vision which drives him. And there will be conflict between what his instinct may tell him is best for the long-term value of the business and what the stock market may tell him is best for the short-term improvement of the share price.
If he has the luck and talent of a Branson or a Goldsmith, he is probably right to turn his back on those conflicts. If he has the wealth of a Bamford or a Swire, he will probably place a high priority on personal privacy, and value the protection which not being involved with a public company affords rather more than he values the prospect of growth and recognition for its own sake.
On the other hand, as Simpson of BZW says, 'Going public forces managements to perform.' There are plenty of examples of private companies, passed on to generations beyond the vigorous founder, which might well have benefited from that extra stimulus and saved themselves from some fearsome family arguments at the same time. The Vestey meat empire is one good example. The pools and retailing group, Littlewoods, is another: it has never been quite the same since the demise of its founder Sir John Moores and has been riddled with squabbles between those of his relations who want to retain control of the business within the family and those who would like to be able to realise their immensely valuable shareholdings for other purposes.
But these are extraordinary stories, which are usually the legacies of extraordinary entrepreneurs. For managers of ordinary growing businesses, unhappy with juggling hefty levels of debt, the choice may be between passing up attractive opportunities or going to the stock market for the requisite capital. While the latter choice brings burdens and temptations, it may in practice be the only way of realising a company's long-term aspirations.
A private company may be in some respects a more perfect model, because the interests of owners and managers are aligned without the interference of misleading stock-market signals. But privacy is a luxury which most ambitious companies cannot afford. And that, in the end, is a key reason why stock markets exist.
Martin Vander Weyer is an associate editor of the Spectator
Anita Roddick - Body Shop
The share price fell sharply after profit warnings in 1992 and then again in May 1995, when investors apparently rejected the explanation that a pause for 'reflection and reinvention' was required. To Roddick, this was conclusive evidence of the City's chronic 'short-termism'
Richard Branson - Virgin Group
Regarded by the City as a bearded balloonist and practical joker, Branson rapidly tired of making presentations to men in suits who had never heard of the rock bands on Virgin's list and resented the restrictions imposed on his own time
Andrew Lloyd Webber - Really Useful Group
The composer and impresario floated his company in 1986 and took it private again in 1990, the market having shown scant sympathy for the risks involved in theatrical promotion
George Walker - Ex-Brent Walker
Took Brent Walker private in 1982 when its property-dealing profits collapsed, but went public a second time in 1985 with an expansionist strategy which the City backed to the hilt, and which eventually ruined him
Alan Sugar - Amstrad Group
Sugar's dislike of the City was cruelly confirmed when it rejected his 1992 offer to take Amstrad private again
Sir James Goldsmith - Ex-Cavenham Foods
With his gambler's reputation and unorthodox private life, the City never warmed to him. He in turn resented the scrutiny of the financial press and declared that 'only a fool or a masochist' would want to be chairman of a British public company
David Codling - Hozelock Group
As a management buyout backed by venture capitalists the garden equipment maker's chances of remaining private and independent were slim: 'In our case the most important effect of flotation is that it has enabled us to take a much longer view of the business'.