The Challenges of Generational Change in a Family Business

March 1, 2015 By in Family Business Tags:

Andrew Carnegie, an incredibly successful American businessman, famously said “Three generations from shirtsleeves to shirtsleeves.” Here, shirtsleeves mean the clothing of a (poor) blue collar worker. This is probably the origin for the more modern day warning “The first generation builds it, the second generation enjoys it, the third generation loses it.”

In the GCC a quick and informal survey of family businesses would suggest that the second generation not only enjoys it, but often is the generation that loses it. This process seems to take years as often as it takes decades. Are there issues that we face that are different from those faced by the rest of the world, or are we just better at squandering family fortunes?

I will argue the former, and that blindly applying global best practice therefore harms regional family businesses. I will pick a number of the more salient issues that should reinvigorate the discussion.

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The Family Holding Company: More Than Just A Legal Structure

February 25, 2015 By in Family Business Tags: , , ,

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With generational change increasing, the idea of institutionalising family businesses has gained wide spread acceptance. The magic formula seems to be create a holding company to hold the shares of the operating companies, a shareholder agreement, a terms of reference for the board and maybe add some independent directors to the board. Focussing on the holding company aspect, there quite often is no strategic plan let alone business plan. The holding company direction is set by the agenda of the constituent operating companies. Talk about the tail wagging the dog.

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The Characteristics of an Alternative Lender

February 24, 2015 By in Credit Tags: ,

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In a recent article, this column laid out the case for the rise of the alternative lender as a natural consequence to the hole left by conventional banks withdrawing from the SME market. This article looks at what a successful alternative lender might look like.

The first step is to understand the relevant characteristics of a conventional SME lender. Conventional banks are, by and large, mature companies with an inflexible and conforming operating culture. This leads to risk rigidity, i.e. banks will usually get comfortable at one point of the risk curve and they will rarely leave it.

This in turn leads to product concentration and possibly myopia at the macro level with innovation only at the micro level. What this means is that the basic types of products do not change, so a salary loan will pretty much be the same at all the banks in terms of tenor and structure. One bank might add a lottery to the loan, another bank might allow deferral of one payment per year, but overall they are the same.

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Moral Arbitrage and the Inheritance Play

February 22, 2015 By in Investments Tags: , ,

The thing about the rational investor hypothesis is that it assumes that investors wish to maximise a financial risk/reward function. They don’t. Investors have a utility function that includes economic considerations, but also includes many other goals important to the investor.

Some investors may refuse to invest in defense companies, especially those that produce offensive weapons. Others may avoid investing in companies based in countries who have policies that they don’t approve of. Still others may reject gambling or alcohol related companies. The list goes on.

Whilst economists discuss such issues ad nauseam, traders make money off it. A non-financially motivated seller nearly always provides an opportunity for the astute, and differently motivated, investor to make money.

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The Hidden Motivation of Entrepreneurs

February 13, 2015 By in Entrepreneurship Tags: ,

People usually misunderstand what it means to be an entrepreneur (read: The Meaning of Entrepreneurship). One of the most difficult issues that they face is their own motivation. The first time entrepreneur usually believes that his primary motivation is commercial. Their actions usually prove that commercial goals are low priority. This schizophrenia causes unnecessary stress to the entrepreneurs and value destruction to the company. Continue reading →

The Poetry of Entrepreneurship

February 11, 2015 By in Entrepreneurship Tags: ,

A well rounded education, formal or informal, is necessary for the success of any entrepreneur. The internet is replete with quotes relevant to the entrepreneur. But the world has offered much more, oh so much more, to the inquisitive mind. Yes, Malcom Gladwell has interesting insights, a look into Steve Job’s life might be beneficial, and maybe you can really learn to work for only four hours a week.

But all of this misses the power of words that connect with you emotionally, at a deep level. The spirit must receive the same nourishment as the mind and body, and what better than the world’s leading poets to provide such nourishment? Who better to capture the spirit of the challenge, the journey, that is an entrepreneur?

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The Investor’s Edge

February 10, 2015 By in Investments Tags: , , ,

Many of the ideas used by the investment community are adopted from the horse track and casino betting communities. Much of the failure that has dogged the investment community is due to rocket scientist PhDs misunderstanding the successful models of plebeian punters. The use of betting as an example is not an endorsement, just history.

To understand how the securities markets work you have to look no further than the horse bookies. Bookies take the bets from the bettors. This is the first point that the public begins to misunderstand how betting, and therefore investing, works.

There are two potential misunderstandings: The first misunderstanding is assuming that each horse has a uniform probability of winning, i.e. they are all just as likely to win. The second misunderstanding is assuming that the bookie offers one to one payout odds, i.e. pays $1 for each $1 that is bet. Grasping the significance of these statements is the key to successful investing.

The bookie, equivalent to the investment bank or broker, will always make money. Always. They do this because they do not set payout odds depending on which horse they think will win, they set payout odds based on how people bet.

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Second Order Questions and Sterilising the Oil Price Effect

February 5, 2015 By in Oil Tags: ,

Consider, if you will, an oil exporting nation. Consider further those nations whose commodity exports far exceed their budgetary needs. What is a nation to do with such excess wealth?

There are two main approaches to this. The first is the more conventional strategy inherited from central banks, in many ways the precursors to SWFs. This method, which I will call risk-off, seeks simply to hold foreign exchange reserves, usually the US dollar, in the form of high quality, low risk assets, usually US Treasury bonds.

The second strategy, which I will call the risk-on, borrows heavily from pension and endowment funds. Investments are made not to protect value, but to create value so as to meet future obligations. Not only is public equity as an asset class targeted, but all manner of alternative investments including but not restricted to private equity, hedge funds, real estate and high yield debt.

So as not to confuse the point that I am trying to make, I would like to clarify that there is no right or wrong to which method a government chooses, as the choice is driven by policy considerations not investment considerations.

Back to our story. If an oil exporting country with a risk-on strategy suddenly faced oil prices dropping by 50%, what is the net effect to its revenue? Using Norway as an example, their circa 1.7 million barrels per day of export would lose USD 85 million per day in revenue or USD 31 billion per year.

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Trading Insights: Exposing the St. Petersburg Paradox

February 3, 2015 By in Trading Tags:

The St. Petersburg Paradox is a famous problem in probability and economics. The problem states that a coin is repeatedly flipped. The bet starts with $2. Every time a tails shows up, the bet is doubled. The first time a heads shows up the game ends and you receive the current bet from the ‘house’. The question is, how much would you pay the house for such a game?

From a probability point of view, the expected payout is infinite, and it is not hard to see why: the payout is doubled each round. This leads us to the paradox: you should be willing to pay an infinite amount to play this game. Most people would refuse to.

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