From the December 2010 issue of Investment Advisor • Subscribe!

December 1, 2010

The Right to Vote

Ownership without rights is the worst of all worlds

One sign that a business is maturing is when its leaders do not fear dissent. This is also a sign that the company has not yet drifted into stodgy bureaucracy. Because the independent advisory profession is relatively young, owners of such practices often struggle with whether to allow freedom of ideas or to limit tolerance for contrary views. Do they seek obedience or seek consensus?

Some firms bounce between free-spirited, open dialogue and a paranoid death grip, like a driver alternately pushing the brake and the accelerator while hurtling down the highway. “Great idea, let’s go with it; no, shut up and do as I say!”

This debate about how to grow an advisory business becomes especially fervent when firm ownership broadens beyond the founder. Should ownership include the right to vote on policies, procedures and people? Should new owners have a real say in how the business is run—not just an opinion, but a vote on issues that count?

There are two familiar scenarios in which the right-to-vote debate arises: 1.) when one advisory firm merges into another; and 2.) when advisors open up the “partnership” to new people who are helping the firm to grow.

Those in control who oppose granting suffrage to others can offer a very rational argument as to why, as founders of the enterprise, they are unwilling to allow new people—especially minority shareholders—to exert influence over the strategic direction of the business. Leaders often fear the possibility of an overthrow if the other shareholders were to “gang up” on them. There are hundreds of examples in professions where upstarts staged a successful coup d’état or collective walk-outs that marginalized another shareholder’s leverage, so this fear is not unfounded.

On the other hand, those who seek voting rights along with the responsibility of ownership believe that this is a natural entitlement, as they are putting themselves on the line for the business—and the other shareholders. They too fear being marginalized. Without a vote, they feel they would have no leverage over the directions and decisions that could affect their stake.

The Merger Dilemma
Lately I’ve been hearing many tales of woe from prospective merger candidates who got all the way to the altar with a larger firm only to be told that their shares would have restricted rights or be of a different class with different features. Non-voting shares often seem to be the final card played in negotiations. This last minute sleight of hand accomplishes only one thing: confirms that they can’t be trusted.

I know one such situation in which two firms were an absolutely perfect match. They had identical investment philosophies, approaches to how they served clients, client demographics and a shared sense of what was important in life. They spent at least a year getting to know each other before delving into the financial aspects of the merger, just to ensure that they were making the right decision. As an observer who knew both firms reasonably well, I was very proud of how they approached their pending nuptials—as a relationship based on transparency and trust, rather than who gets paid what and who controls what. The terms of the merger included an exchange of shares based on an independent valuation of both firms.

The principal shareholder of the larger practice told the sole owner of the smaller practice that they were very excited about the impact of the merger on both their businesses. “But,” he said, “upon deliberation of what this means for us, my partners and I decided that we would not give you voting shares as part of the deal. We never want to be in a position where you could team up with the other partners and outvote one of us. Nor do we want to be in a position where your vote steers us in a direction one of us might not want to go. My partners and I worked hard to build our business relationship and are concerned that if we allow you voting rights, this foundation could be disrupted.”

Unfortunately, the owner of the smaller firm felt that the way the dominant firm reacted to the mere request for voting rights was a red flag, signaling an obsession with absolute control that was out of sync with what they had represented in all the discussions to this point. While not on the scale of the Israelis and Palestinians, such a high level of mistrust of how the other will behave once the deal is signed creates a stalemate, not a solution. How did the advisor of the smaller firm respond to this disappointing announcement? He said, “By them saying I would not get the right to vote was such an incredible breach of trust, that even if they apologized and said it was a mistake, I could not consider entering into the merger with them.”

Ironically, the larger firm is still actively seeking to tuck in other advisory firms to create critical mass, and possibly a regional or national brand made of like-minded professionals. It’s hard to imagine many scenarios in which an independent advisor would give up total control, albeit of a smaller entity, for the risk of merging into a larger firm in which they will have no official voice—except the right to quit and start over again.

While the larger firm might find takers, the smaller firms will have to make sure that they get financial credit for trading a majority interest value in their business for a non-voting, minority interest in another. The value of shares in this scenario is not equal. But this is not a financial decision alone. People who go into business with each other, especially as partners, need to be able to trust their peers to do the right thing and to always act in the best interest of the other.

Do Voting Rights Matter?
Disagreements are merely hurdles in a relationship, whether two people are involved or many. Big companies are not the only ones with “politics.” Politics include the art of managing relationships, getting along, and negotiating reasonable compromises. Subjecting everything to a vote dilutes one’s ability to build consensus or negotiate an acceptable approach.

Further, what both sides in the right-to-vote debate seem to miss is that voting has no place in the normal course of making everyday management decisions. In a closely-held business, voting is limited to the sale of major assets, liquidation of the business, declaration of a dividend and, as a practical matter, termination of another shareholder or executive.

Ongoing management, however, is most effective when the company’s leaders are empowered to make decisions and take action on behalf of the business without having to take a vote. Effective leaders discuss, deliberate, consider other perspectives, and then act. Just imagine if your practice was run like Congress!

Of course, the best managers solicit opinions from their partners and other people in the know in order to consider all relevant points of view and also to create buy-in. The worst leaders lead by position, such as ownership; the best leaders lead by persuasion, where they show empathy, understanding and the ability to get others to follow. And in the end, if leaders underperform according to the expectations set up by the firm’s Executive Committee, board, or shareholders, then they will have to endure the consequences of losing their jobs. I rarely see decision-by-committee produce a better outcome than decision-by-accountability.

For advisory firms that admit new partners as part of a career path and business continuity plan, it is important that they avoid creating a caste system for different levels of owners. Done properly, if the candidate for ownership passes the threshold issues that got him considered to be a partner in the first place, then the current owners should not fear the consequences of giving as much voting weight on a relative basis to the shares that new partner acquires. If there are concerns, then the current shareholders should consider whether the time is right to admit a new member to the club. Functionally, denying new partners voting rights excludes them from full membership anyway.

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