The owner’s manual

familyandtrends recently highlighted, amongst the tasks of the Academy specialising in family entrepreneurship, the need to develop a theory of family business ownership. In this context, an interesting document is the ‘owner’s manual’ written by Warren Buffett for Berkshire Hathaway, the largest and most successful investment company of our time. Buffett, however, is not a great admirer of family capitalism, which he has often referred to as ‘The Lucky Sperm Club’. The document was written in 1999, following the merger with General Re, which increased the number of Berkshire shareholders and made it appropriate to provide new shareholders with a handbook to help them understand their new company. Even today, that document offers interesting insights into family capitalism.

The first: the importance of commitment. Buffett writes: “We eat what we cook… Charlie’s [Munger, Buffett’s long-standing partner] family has 90 per cent or more of its net worth in Berkshire shares; my wife Susie and I have more than 99 per cent. Furthermore, many of my relatives – my sisters and cousins, for example – hold a huge proportion of their wealth in Berkshire shares.” This is a distinctive and widespread feature of family businesses. To safeguard this, anyone wishing to be involved in the business, in whatever capacity, must have ‘skin in the game’. The handbook continues: “Charlie and I cannot promise you results. We can, however, guarantee that your financial fortunes will move in lockstep with ours... We have no interest in receiving large salaries, share options or other incentives that would give us an advantage over you.” In family businesses, this principle often means that family members involved in the business are ‘underpaid’. This does not create tensions in the first or second generation, where, as in Buffett’s case, major shareholders are often directly involved in the business; in subsequent generations, however, it is advisable to find mechanisms that recognise, in a balanced way, the greater commitment and results achieved by family members who, perhaps, hold smaller ownership stakes as a result of generational transitions.

Secondly: honesty in communication. “Over time, virtually all our activities have exceeded our expectations. However, every now and then we also experience disappointments, and we will try to inform you of these with the same candour with which we tell you about our most positive experiences… At Berkshire … we will always tell you how many strokes we took on each hole and we will never tamper with the score on the scorecard.” It is never easy to share, especially within the family, the things that have gone wrong or the mistakes that have been made; often there is a fear of seeing one’s authority diminish and of losing the esteem of partners who have believed in and often appointed those who lead the company. The best advice to give to business leaders in such cases is to recall Montanelli, who said: “I never find it difficult to admit I was wrong, because I am convinced that infallibility is the exclusive preserve of God and fools.”

Thirdly: the importance of continuing to invest with a prudent dividend policy. “Over time, we have found that retained earnings … have been … beneficial. This positive outcome has arisen because most of the companies in which we invest operate in truly excellent businesses, which often manage to deploy new capital very effectively: either by reinvesting it in their own operations or by buying back their own shares… We believe that noble intentions must be periodically tested against results. We gauge the wisdom of the decision to retain earnings by assessing whether, over time, every dollar retained generates at least one dollar of market value for shareholders.” Deciding to leave the wealth generated within the company is the best way to continue growing it. The shareholder family renews this decision every year, when the dividend is determined.

Fourth: debt, in moderation. “We use debt sparingly and, when we borrow money, we try to structure our financing on a long-term, fixed-rate basis. We would rather pass up attractive opportunities than overburden our balance sheet with excessive financial leverage. This prudent approach has held back our results, but it is the only course of action that gives us peace of mind, given our fiduciary duties towards … our lenders and the many shareholders who have entrusted an unusually large proportion of their personal wealth to our management. As one of the winners of the Indianapolis 500 put it: ‘To come first, you have to get to the finish line first.’ Prudence in the use of debt is a characteristic confirmed by all research into family businesses. The reason is that entrepreneurs follow the same line of reasoning as Buffett: ‘The financial calculation that Charlie and I use would never allow us to sacrifice a good night’s sleep in pursuit of a few extra percentage points of return. I have never believed it makes sense to risk what my family and friends have and need, in order to try to obtain what they do not have and do not need.” The fact that this is said by Wall Street’s greatest investor – who, for a long time, has been more successful than all the heavily indebted companies and all the highly ‘leveraged’ hedge funds – supports the soundness of Italian entrepreneurs’ decisions. However, this should not lead us to believe that it is always better to open up the company’s capital to third-party investors rather than take on debt. The same handbook states: “We will issue shares only when we receive, in terms of the company’s economic value, at least as much as we are giving up.”