A flood of buy-backs
Peter Flood
The Flood Company, Hudson, Ohio
In more than 20 years at the helm of his family’s 156-year-old paint contracting company, Peter Flood confronted several waves of liquidity demands from active, inactive and non-family shareholders.
The first wave began in the late 1970s, when the firm gradually bought out five of six inactive relatives who wanted to cash out their shares.
“Part of our cultural value was not to pay dividends to shareholders,” says Peter, who’s now 50. “Stock ownership provided a connection and future value,” he says, but not current income.
Unlike many closely held family companies that ignore their shareholders’ liquidity needs, the Flood Company has always been willing to buy back shares. “Over time, at one point or another, they all wanted to cash out,” adds Peter.
In the early 1980s, for example, Peter was about to acquire a new crop of inactives with the retirements of his father, his Uncle Warner Clark and his brother-in-law Gordon Anthony. At the suggestion of an adviser, Peter restructured the company from a C corporation to an S corporation, allowing the company to drain all retained earnings and pass that value in the form of preferred stock to the retiring family managers. That strategy essentially allowed incoming active fifth-generation owners to acquire the company free.
“There wasn’t a lot of retained value,” Peter explains, “but everything was paid for, and we had the ability to earn money and build the value back up.” (Tax laws prohibit such transactions today.)
The big hurdle was allaying the relatives’ suspicions. “There were spouses involved who said, ‘OK, I can take your word for it, but can you show us how it’s going to work?’” Peter recalls. “I had to build a case and show them what was driving the growth and what we were looking for during the next few years. We beat those projections.”
More recently, in 2001 the company decided to undo an employee stock ownership plan it had put in place in 1992. Peter wanted to buy out the firm’s 130 employees, who together owned 40% of the company. Sales were growing by about 10% a year, but in an overheated economy the stock valuation was growing even faster.
“Frankly, I’d rather fulfill the company’s promise to pay off all the ESOP stockholders at the time that promise was shining the brightest than when it dulled down,” Peter says. “If I’d waited for the stock price to cool off, employees would have had a hard time believing that what drives me in business was having them share in the success.”
Flood Company ultimately replaced employee ownership with a profit-sharing plan, so employees can still benefit from the company’s growth.
Buy them out
Gerald ‘Skip’ Daynes
Daynes Music Co., Midvale, Utah
Pioneer John Daynes lugged a 600-pound organ westward in 1862 to open Utah’s first music store. But Daynes Music Co. barely supported grandson Royal Daynes and his family through the 1930s Depression, which forced him to shutter all but one of their 25 piano and organ outlets. Royal’s son, Gerald Sr., relied on the store to support his family in addition to three inactive sisters, each an equal owner.
“My father never had control of the business,” laments Gerald “Skip” Danes, 65, the current fourth-generation owner. “It was part of the reason he was not very animated and didn’t enjoy it. If he did very well, [his sisters] would be doing just as well, and they didn’t have to work like he did.”
Skip says he’s careful to avoid the problems his father encountered. When his father retired early—at age 61 in the early 1960s—Skip bought his stock, even though the company was $97,000 in the red. He also bought out his three aunts’ stock over some three years. “It was hard work,” he recalls, “and I earned very little to do that.”
As an unexpected side benefit, Skip’s own younger brother and sister, now 59 and 63, witnessed his struggle and lost interest in claiming a piece of the company. “We’ve never made a lot of money,” Skip says, “and it’s always been hard.”
That may change soon. Thanks to an unexpected boost in institutional business, Daynes Music may scale up from its average $6 million a year volume to between $18 million and $22 million this year, Skip says.
With this reversal of fortune, Skip imagines his brother or sister might regret not having entered the business. “They might say, ‘Maybe I could have had a piece of that,’” Skip says with a laugh. “A piece of what? It’s a nice-looking certificate, but it really has no value. I gave one share to my father-in-law one Christmas. It looks nice on the wall, but it’s more of a joke than anything.”
Policies for a shrinking family
Troy Coppage
E.A. Clore, Madison, Va.
When any family shareholder dies at furniture maker E.A. Clore, company policy grants the firm the right to purchase the late holder’s shares.
The idea is “to maintain control by people who are directly or have been directly involved with the business and are familiar with the business,” says Troy Coppage, who’s a sixth-generation shareholder and the company secretary. So far, the company has always had enough capital to exercise that policy, which was instituted in the 1970s by fifth-generation owners.
The family’s growth spurt in Generation Four may have inspired this policy, says Troy, 36, whose great-grandfather, E.A. Clore Sr., had six boys and six girls. Without the buy-back option, ownership and control by active owners would have been greatly diluted.
The policy poses one potential problem: An active owner can still own shares—even a majority stake—after retiring or quitting. Retirees tend to be more risk-averse and may prefer the company to earmark cash flow for dividends, not reinvestment. That could cause a problem bigger than stock dilution.
But Troy shrugs off that concern. The company’s current inactive shareholders—including Troy’s 93-year-old great-uncle, Daniel “Nat” Clore Sr.—“worked at the company their whole lives,” he notes. “There simply has never been an issue.”
Nor does there seem to be an issue for future family members who may one day want to join and own the business. While ownership isn’t automatic for active members—Troy worked at the company for seven years before he was able to purchase shares—the opportunity is there.
Actually, few Clore family members are involved in the company today. Troy’s great-uncle, Daniel “Nat” Clore Sr., retired before Troy joined the company in 1984 but still serves on the board as a shareholder. His son, Danny Clore Jr., 62, is president. Danny Jr.’s daughter, Sara Utz, 38, is treasurer, and Troy’s father, Billy Coppage, 59, vice president.
Troy cites two reasons why family involvement has decreased. First, “an awful lot of family have moved to other places and chosen to move on. They stay in touch but do not really desire to know all the goings-on of the business.” Another factor: “The name is dying out,” Troy says. “Few of the boys had boys who had boys. It’s just one of those things.”
Nevertheless, Troy believes the company and its policies “do more to connect than to divide.” Whether members work or own stock, “a good part of the family shops here,” eve without a discount, he says. “With the reputation our company has, most family members are certainly proud to be connected to the business, to be part of the same family.”
‘That was the end of the dividends’
Kurt Schmidt
A.E. Schmidt, St. Louis
Kurt Schmidt had been with his family’s billiard-table manufacturing company only a few years when he decided to clean out the firm’s 50,000-square-foot warehouse. He found all sorts of abandoned tables and parts in various stages of manufacture, dusted them off, and put them back in the pipeline for completion and sale.
That reclamation of lost inventory created a large profit, which inspired the board of directors to pay a dividend—the only dividend in the past 20 years—to the company’s 52 family shareholders, only seven of whom actually worked there. Kurt found himself more annoyed than pleased. “It just kind of aggravated me,” he says. “I really wanted that money to improve the company and update it. Most of our stuff was 70 years old and worn out. We hadn’t bought a new piece of equipment in 15 years; the showroom floorboards were curling up. Machinery needed to be purchased; there were a million things we needed.”
The underlying problem lay with the company’s governance. “We had so many people making decisions that we couldn’t get any decisions made,” Kurt recalls. “At board meetings, we’d sit for three hours and argue about the way something should happen without making any decisions.” Kurt had already experienced these frustrations second-hand when his parents were in charge. “They were never given a chance to own the whole company,” he says, “even though they were putting all the work in.”
Kurt met with the board and, largely through the force of his own conviction, persuaded them that before they shelled out any more dividends, they should “look at the facts.” Fortunately, he says, they agreed. “So that was the end of the dividends.”
Since then, 44-year-old Kurt and his wife, now the only two remaining family employees, have bought out all but 15 inactive family members. “It’s a control issue,” Kurt acknowledges.
The remaining 15 inactive owners have held onto their shares, “not because they think they’ll get rich, but because it’s part of the family legacy,” says Kurt. “Most companies are a pretty good deal for descendants,” he adds. Yet companies like his “provide a living for people working there, but don’t create huge amounts of profits each year. I do’t think anyone expects they’ll inherit $2 million when their uncle dies.”
The company limits its communication with inactives to quarterly and annual financial statements. What he gets back in return, Kurt says, is “a lot of encouragement.”
Avoiding a nightmare scenario
Jonathan Phillips
A. Phillips Hardware Inc., Albany, N.Y.
Jonathan Phillips, president and co-owner of A. Phillips Hardware Inc., has always co-existed serenely with his two inactive siblings—especially since his father, Abbott, still controls the chain of six hardware stores as the majority owner. Jon used to worry what might happen down the road if his inactive brother and sister (who owned no shares) were to inherit stock. If they disagreed about a business decision and used their shares to outvote him, “All of a sudden I would have no control of the business,” he says.
To avoid that scenario, Abbott transferred common shares of the company to Jon, while retaining control of the voting stock. Then Abbott spun off the real estate portion of the business into a separate limited liability corporation and made his three children equal owners in terms of value. Jon gets to decide how much rent to charge the 117-year-old company and whether or not, eventually, to sell any of the buildings.
“I wanted to protect my interest in the company and get the right game plan for the business instead of waiting for something to go wrong,” Jon explains.
His siblings have no problem with this arrangement, he says, perhaps because his sister’s husband is the company’s lawyer. “That might sound unethical, because he could be tainted to skew things towards my sister’s side,” he says.
On the other hand, “My running the business for the last 11 years has secured the assets my brother and sister get. They respect the fact that I’ve maintained the company, and that they’ve gained from my operating the business. I think all of us are happy with this arrangement. Now we’re all involved in growing our net worth as a family together, but how will we handle it after he dies?”
This is one scenario that doesn’t trouble Jon. “We have a structure in place legally, and everyone knows what happens that day.”
Jayne A. Pearl is a freelance writer based in Amherst, Mass. She is the author of Kids and Money: Giving Them the Savvy to Succeed Financially (www.kidsandmoney.com).