Look at the company from a shareholder’s perspective
The title of this article might lead one to conclude that this piece is about public companies. While that is true to a large extent, activist shareholders & corporate governance is a topic that applies surprisingly well to private companies where the company stock is held by multiple shareholders. Shareholder activism in private companies typically gets resolved in a private setting and goes largely unreported except in the cases of some highly visible startups. While no statistics exist that we are aware of, empirical evidence suggest that the threat of activist shareholders is probably higher in private companies than in public companies.
Over the past few years, there have been several high profile stories about shareholder activism and how investors are pressuring companies, small and large, to pursue strategies based on shorter term results. Typical areas of contention include cash hoards and M&A strategies – areas that have traditionally been the exclusive domain of management teams and boards. By impinging on decision making in such areas, activist shareholders are not only pushing their agendas effectively but also causing unprepared managements to make mistakes.
Activist shareholders pursue their aggressive strategies because past experience indicates that activism works. For example, in 2012 and 2013, Goldman Sachs estimates that activist funds have returned 40% compared to 23% for a typical hedge fund. This kind of performance is likely to further increase shareholder activism. In this environment, proactive management and board oversight are very important, as the consequences of inaction can be severe. Companies can face legal and regulatory challenges and, in some instances, activist shareholders can successfully oust management and board members.
A good plan and process will allow management of the company to expend a minimal amount of time on shareholder issues if and when activist shareholders surface. Management can better handle the situation while continuing to focus its attention on the company’s operational and strategic issues.
When developing a plan to counter shareholder activism, the following are some key areas for proactive consideration:
Understand the types of shareholders and their needs
Growth investors, value investors, and arbitrageurs all have different expectations on how they like the company to perform. Long term investors invest for long term growth or dividends. Short term investors buy for short term stock appreciation and arbitrageurs buy to exploit specific arbitrage opportunities. Management may encourage a specific type of shareholder but there is no guarantee that the shareholders will match management’s desires at any point in time.
Understand the changing dynamic of shareholder profiles
It is important to track shareholder types and how they are changing over time. Change may come in different ways – the shareholder base may be changing over time, or the needs of the long term shareholders may be changing over time. A growth shareholder of yesterday may be a value shareholder today. Shareholders are the happiest when the shareholder type matches the company’s current stage (high growth, low growth value, fixed cash flow, turn around, etc).
Identify potential pockets of shareholder activism
If the company’s shareholder type is not consistent with the company’s business stage, or if the shareholders have a different set of expectations than management, then it is likely that management will face a shareholder revolt. Management needs to aware of lack of consistency between the company’s direction and its shareholder needs, and take appropriate action.
Understand activist shareholder tactics
Short term investors, in spite of their ill-gotten reputation as vultures, add value to the ecosystem by highlighting a company’s mismanagement of assets and questioning the company’s strategies. They can be extremely persuasive and resourceful and may use tactics that highlight and amplify management deficiencies. Managements need to be keenly aware of the tactics that an activist shareholder has employed in the past or may employ in the future.
Pre-emptively address potential hot buttons
It is important for management to anticipate potential shareholder activism areas, such as cash hoards, dividends, mergers, acquisitions, divestitures, share buy-backs, and under performance. It is possible that the activist shareholder concerns are legitimate and management needs to take corrective actions to address deficiencies. It is possible that shareholders concerns reflect a profound misunderstanding of the company’s tactics or strategies. It is also possible that the activist shareholders have very different sets of goals than the management.
Regardless of the reason, pre-emptively communicating the company’s strategies and tactics to shareholders on a regular basis will help alleviate the problem. It also helps management and shareholders better understand the other side.
Have a process to address activist shareholders
When addressing activist shareholder issues, it is always a good idea to look at the company from an investors’ view point. Having a good process that facilitates good communication and helps understand the shareholder base is essential. Good communication is probably the easiest way to address many early stage shareholder issues. Having a well-defined process to communicate with shareholders and board members is critical to addressing shareholder activism before it becomes a bigger problem. Ad hoc process will more than likely lead to resentment from both activist and non-activist shareholders.