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Is the pursuit of equity a better business model?

  1. The Byre

    The Byre UKBF Legend Full Member

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    We are being told that the high street is dying and that extortionate rents and business rates are to blame.

    On one hand, councils are at last listening to complaints about business rates, following the Government’s decision to cut them for most small retail properties in April. On the other, landlords are proving reluctant to reduce rents to realistic levels.

    But are lower property costs the only hope of salvation for high street businesses? Or is it time to rethink the focus on profits and look at those companies that have grown by developing equity?

    Building equity

    My very first proper business was a shop, and that went so well that I was able to make the down payment on my own place within a year. I still own that building and nearly 40 years later, it continues to pay a monthly rental. Yes, the original rented shop was in a better location, but I learnt how to garner equity early on and to do it as soon as possible.

    In our private lives, it’s a good thing to get onto the property ladder as soon as possible then develop equity in our homes and elsewhere, with pension funds or similar schemes.

    The attitude is different among SMEs in the UK and the US, however, which seldom seem to see a need for developing equity. Instead, most prefer to seek funding from outside investors, or otherwise try to use other people’s money.

    If you are thinking of starting up a facilities-based, bricks-and-mortar business, you are in the real-estate business, whether you like it or not. But you have to decide which side of the real-estate desk you are sitting on.

    To explain just how significant this difference is, one example springs to mind. Around 15 years ago, a music industry magazine reported that a recording studio in a converted cinema in North London had closed down. It had been struggling, more or less running at a loss, so its 65-year-old owner decided to sell up.

    To the owner's amazement, he sold the building for £4 million. It was not running at a loss at all. During all that time, the business was not just covering its costs, it was also adding equity to its  bottom line.

    Adding value

    I began my business career in Germany and there, the doctrine of 'other people's money' is not usually followed.

    The Germans have a word for most things, and while there I learnt the principle of Wertschöpfung: to add value. This applies not only to the production and marketing processes, but to every aspect of the business, both financially and ethically. The company has to be worth more tomorrow – economically and morally – than it is worth today.

    Wertschöpfung within a company is seen as improving the value of every aspect of a business. The health of employees, their careers and their development, relations with the customer, the quality of the products, and the net asset value of the business. Wertschöpfung is a very different way of looking at a business.

    The idea of adding ethical, moral and economic value to a person and to an enterprise is hardly new. The principles have been discussed by Socrates, Plato, Christ, Buddha and Confucius, and more recently by 20th-century philosophers Max Scheler and Erich Fromm as well as platoons of authors and professors after them.

    Admittedly, nobody could accuse most German companies in the 1930s and 1940s of seeking the moral high ground. Even today, large German companies are not ethically spotless – Volkswagen sparked fury over Dieselgate in 2015, and becoming a union activist is a great way to lose your job at Aldi. Yet both are regarded as exemplary employers and prime examples of the doctrine of Wertschöpfung.

    Family affairs

    The motor behind the German economy is largely the 'Mittelstand' – the medium-sized company. These are nearly always family affairs and privately owned, and for these businesses, Wertschöpfung means the family owns the company as it grows in value. Many have become giant international concerns and in the UK retail trade, German private and self-financing family companies Lidl and Aldi are changing the way people shop.

    Beyond retail, automotive giant BMW is 50% privately owned by members of the Quandt family. Bosch, whose components and software are in every modern car, as well as manufacturing just about anything and everything electrical, was a totally private family company and is today 92% owned by a charity for social and medical research created by the Bosch family. Another international company that began life as a small German print works is Bauer Media, 85% owned by Yvonne Bauer.

    And then there’s the giant Porsche Automobile Holding, which – through the Porsche and Piëch families – owns a 52% stake in Volkswagen voting shares. You may have thought Porsche was a Volkswagen company, but in reality, it is the other way around. Walmart is still controlled by the Walton family. Swiss pharmaceuticals giant Hoffmann-La Roche is controlled by the heirs of Fritz Hoffmann-La Roche.

    What these and many other family-run private companies have in common, from Aldi to our local plumber and yours truly, is equity. They either own the ground they stand on outright or the equity is about one third to a half of total assets. Aldi owns nearly all its shops. Lidl even has its own harbour buildings at London Gateway. Both are private, family-owned companies.

    Reducing risk

    By not using outside investors and IPOs, these companies cannot enjoy the sudden, almost explosive growth enjoyed by companies like Tesco in the 1950s and 1960s, or the online giants like Facebook and Amazon. It is almost as if they are pulling a giant weight behind them – the weight of having to find their own money every time they seek to expand. That means initial growth may be slow, but it also means that the company is exposed to less risk.

    Startups are notoriously bad at managing risk. No one is quite sure what percentage of startups fail in the first ten years, but a study by Harvard Business School puts it at 70%. The top reason for failure was 'lack of demand' followed by 'ran out of cash'. If you are renting your bricks-and-mortar, leasing your vehicles and have outside investors insisting on seeing dividends, running out of cash is going to come a whole lot sooner. The equity-based private company has a cushion to fall back on.

    Downturns in trade happen, they are unavoidable. The high street has seen a welter of disappearing acts during these downturns. Woolworths, Fine Fair, Netto, Sommerfield, Maplin – the list goes on and on, and is truly bewildering. Businesses seem to come and go like the snows of winter. And with each disappearing business, jobs and careers vanish – and, of course, new opportunities open up for better-funded and more focused enterprises.

    Perhaps, if you focus on developing equity, you may be one of them.

  2. Nochexman

    Nochexman UKBF Enthusiast Free Member

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    Excellent article!
    Posted: Feb 20, 2019 By: Nochexman Member since: Jun 14, 2011
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  3. Talay

    Talay UKBF Big Shot Free Member

    3,832 800
    Just buying a retail outlet with accommodation upstairs. Barring the 25% down, the return outstrips the mortgage by about 125% now and as we occupy downstairs, we will never suffer rent increases and in 10 years it is all paid off.

    Even if I net the cashflows to buy versus rent saved, the 25% down increases to 100% owned after 10 years. That's a fair return.
    Posted: Mar 22, 2019 By: Talay Member since: Mar 12, 2012
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  4. smallclaimsassistance

    smallclaimsassistance UKBF Enthusiast Full Member - Verified Business

    918 257
    "The attitude is different among SMEs in the UK and the US, however, which seldom seem to see a need for developing equity. Instead, most prefer to seek funding from outside investors, or otherwise try to use other people’s money".

    So true! This has always mystified me about business in this country.

    Great article.

    Posted: Apr 6, 2019 By: smallclaimsassistance Member since: Jan 7, 2015
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