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Low Corporate Governance for Controlled Companies Part II

[vc_row][vc_column width=”2/3″][vc_column_text]Last week I demonstrated the interesting phenomenon of stock market investors who were willing to buy shares, and, in some cases, at a high price to earnings ratio, of companies that had openly stated that they were not interested in having independent directors, having a committee to nominate directors or a committee to review compensation terms for management. One more thing, these companies had little to no shareholder rights. Amongst the egregious governance dodgers are the little known Google (or rather, Alphabet, its parent), Berkshire Hathaway and Facebook.

ISS Governance, an independent corporate governance rating agency, gives NYSE and NASDAQ traded companies a quality governance score based on four pillars: audit and risk oversight, board structure, shareholder rights and Compensation. On a graduating scale of 1 to 10 with the latter being the lowest score and therefore demonstrating higher governance risk, Facebook’s governance score is a resounding 10! It gets a good score of 2 for audit but everything else slides into governance oblivion when board structure rated a 10, shareholder rights rated a 9 and compensation rated a 10.

How do these companies do this? Their capital structure typically has two classes of shares: Class A and Class B. So the owners of a private company who wish to go public to raise present or future capital, or help establish price discovery for the value of their shares, can still maintain tight control over decisions, while diluting their ownership using a dual class share structure. In a case like Facebook, Mark Zuckerberg owns only 18% of the common stock but has over of the 50% voting power, largely by structuring the class B shares that he owns to have ten times more voting power than the regular class A shares. According to a Forbes magazine May 2012 article titled “ Facebook Ownership Structure Should Scare Investors More Than Botched IPO”, these kinds of structures are fairly commonplace in Silicon Valley with the likes of Google, LinkedIn and Zynga. It is also noteworthy that other big brand names like Nike, Ralph Lauren and Estee Lauder have similar structures.
According to Investopedia, the common practice is to assign more voting rights to one class of shares than the other to give key company insiders greater control over the board and corporate actions. These super voting share structures are also good defenses against hostile takeovers where a party can purchase a significant quantity of shares on the open market as to demand a seat at the board table.

Controlled companies are able to do this because NYSE and NASDAQ rules permit these structures for as long as there is full disclosure at the Initial Public Offering stage, and further ongoing filing disclosures. These disclosures should state exactly what corporate governance standards the company is failing to comply with. Thus the American stock investor has to be savvy enough to research the share structures of the companies they wish to purchase before rocking up at the Annual General Meeting and making a fool of themselves demanding to see compensation policies for senior management and all that independent director nonsense that good corporate governance dictates.
But why should the ordinary Kenyan business owner care about all of this? Were such structures permissible on this side of the pond, then it’s fairly safe to assume that we would see more family owned businesses view the Nairobi Stock Exchange as a viable option for capital raising and price discovery without the requisite nuisance value that external shareholders are viewed to bring. A good example would be the supermarket chains such as Nakumatt, Tuskys and Naivas. Or the big local manufacturers like Bidco and Menengai Oil. The flip side of the argument is that without good corporate governance, the current cash flow issues clearly facing Nakumatt’s management would severely infect investor perceptions of other family owned businesses with opaque board structures and have a knock on effect on their market valuation. Controlled company structures require tightly run management practices that stand the test of economic vagaries. With only about 6% of American companies having these kinds of structures it demonstrates that it takes a special kind of owner to convince external shareholders to just forget about governance and put your money where our mouth is!
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Twitter @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

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Can You Learn To Unlearn

“The illiterate of the 21st century will not be those who cannot read or write, but those who cannot learn, unlearn and relearn.” Alvin Toffler, Futurist

I recently attended a talk by a South African futurist, Craig Wing, who began his talk with the quote above. Learn, unlearn and relearn. Craig walked the audience through technological megatrends that should keep every single corporate leader’s nose glued to their smartphone. To begin with, a 2014 study of the average life span of American companies on the S&P 500 Index by Standard and Poor’s yielded interesting results. In 1955 the average life span of an American company on the index was 61 years. In 2016 the average life span was 21 years and by 2027, projections based on current data estimate that the average life span would be 14 years. There is no better evidence of how this happens than outgoing Nokia CEO Stephen Elop’s quote in 2013 following the takeover of the company by Microsoft: “We didn’t do anything wrong, but somehow we lost.” The seemingly defeatist statement understated the myopic nature of the firm as it cruise controlled itself from relevance while Apple and Samsung were flat footing the accelerator in the smartphone space.

Another industry at a confluence of shifting consumer preferences and channel disruption is the retail industry. Singles Day in China falls on November 11th every year, or, more aptly 11.11 as the digit one purportedly looks like a solitary individual. The festival is a product of Chinese social culture amongst the youth to celebrate the fact that they are proud of being single. It has evolved into the biggest online shopping day in the world and a wonderful thumb up the nose to the more insular Valentine’s Day culture. Alibaba, the Chinese largest online shopping portal has registered phenomenal growth on this day alone. Sales in 2013 were US$ 5.8 billion, $9.3 billion the year after [when Facebook’s annual revenues were US$ 12.5 billion], $14.3billion in 2015 and tripling the 2013 numbers to a whopping $17.8billion in 2016. I forgot to mention one notable point: These were sales taking place within 24 hours, translating into processing numbers of 175,000 orders per second and 120,000 payments per second on their own payment platform Alipay. In the digital payments world this is the great grandmother of server challenges!

A pivotal part of Alibaba’s strategy is vertical integration, essentially ensuring a transaction gestates from an online conception into a physical delivery. Consequently 1.7 million couriers from 4,000 different retailers shipped 657 million packages out of 5,000 warehouses as a result of Singles Day 2016.
A Forbes magazine article covering the spectacular sales summarized the phenomena thus: A day in China is now bigger than a year’s online sales in Brazil.
Here’s the clincher: 82% of those sales were on smart phones!

The average life span of companies is shrinking largely due to the colossal analogue thinking that straddles boardrooms. Our “normal” as we know it no longer holds true, not when we can drive across Kenya from Mombasa to Busia carrying nothing but a toothbrush, an empty wallet and a mobile money filled phone while never lacking food, fuel and shelter.With the youth bulge that all African economies are facing, the current and future customer for a Kenyan business is more likely to be under 35 years of age, and doing most of their utility payments, banking, social interaction and entertainment off a smart phone. They are the ones who will ensure that Kenyan companies’ life spans shrink unless the corporate thinkers unlearn their current ways and relearn the rapidly shifting customer preferences. The unlearning is not only limited to customer preferences though, a highly differentiated approach will have to be taken towards the employee value proposition too. Employees are no longer in it for life, that’s been left to the KANU stalwarts. Keeping youthful talent is less a question of how much you pay, and more a debate of whether your company has a cause they believe in. Because the minute the values are diametrically opposed to what management actually does, many of these young folk walk. The question to ask yourself this week is, can you learn to unlearn?

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Disruptive Forces Needed In Banking

[vc_row][vc_column width=”2/3″][vc_column_text]Mark Zuckerberg came, saw and conquered. Kenyan social, print and television media was alight with highlights of his visit and for good reason. Our hotbed of innovation is presumably a key driver for choosing the country in his Africa tour. And given the rate at which banks are submitting themselves to the interest rate capping law, financial innovation should now be a logical outcome of the compressed margins and resultant lower profitability within the banking industry.

But let’s park that aside as this was all about Mark and his globally transforming social media platform that has now become a rapidly growing business tool. I first heard about the disruptive use of Facebook as a credit scoring mechanism at a G20 financial innovation conference in Turkey last year. A panelist from the American online lender Kabbage Inc. informed participants about how their credit lending algorithm went beyond the traditional, historical and fairly outdated banking industry credit assessment mechanisms. They used a borrower’s online persona to determine ability to repay using a variety of parameters and one of those parameters was the borrower’s activity on Facebook.

In a Forbes Magazine article titled “The Six Minute Loan: How Kabbage is upending small business lending” the genesis of the growth of Kabbage is well articulated. “The seeds of Kabbage, founded in 2008 and based in Atlanta, were sown by Rob Frohwein, an intellectual property lawyer. Now CEO, Frowhein saw how much data was becoming accessible via the cloud and that companies like eBay and PayPal were providing application programming interfaces that a lender could use to get real-time access to a business’ customer transaction data. Kabbage, Frohwein says, put the two concepts together. One reason Kabbage has been able to attract capital is its loan default rate. Even though it can assess applicants in minutes and never demands a personal guarantee, Kabbage says its loans are as likely to be repaid as those of traditional banks, which routinely take weeks to make a decision.”

Now this is a very interesting concept. While interest rates are coming down rapidly within the banking sector, loan approvals for unsecured personal and SME loans will not necessarily increase in tandem as the risk profiles of customers is not in any way changing. Yet these borrowers need a source of financing and Kenyans are about to wake up to the often beaten, but much ignored, drum that pounds the message: borrowers are as indifferent to rates as they are as desperate to get a loan approval. Back to the Kabbage story from Forbes, “Frowhein says Kabbage targets established businesses rather than startups, with its automated model assessing three factors: capacity to repay, character and the consistency or stability of the business. ‘We believe we get to know a small business better by being connected to their data sources electronically than any loan officer can do by sitting down at a desk with the borrower,’ says Frohwein. He says Kabbage incorporates nontraditional metrics such as a company’s Twitter or Facebook followers, as well as the online reviews of its customer’s posts as a way to round out an applicant’s story. ‘You won’t get a loan because you have 7,000 likes on your Facebook page,’ he says. ‘But we might increase the cash available to you if you have an active social media following because it establishes the credibility of your business with its customers.”

Now for all the banter I saw on social media about the number of countries that have interest caps, with some pundits including the United States in that category, this will come as a surprise. The average annual percentage rates (APR) of Kabbage’s loans to its American small business customers are 40%! The same article quotes Frowhein as saying “the rates range form 1.5% to about 20% for the first two months of the loan, depending on a variety of risk factors and how long the cash is kept, and then drop to 1% for each subsequent month.”

Yes. I see you. I see the wide saucers that your eyes have become. Let me provide you with the definition of APR: An annual percentage rate is the annual rate charged for borrowing and is expressed as a percentage that represents the actual yearly cost of funds over the term of the loan. This includes any fees or additional costs associated with the transaction. So your Kabbage borrower is someone who has been unable to get a loan approval from a bank for whatever reason (more often than not a poor credit rating score, or worse, no credit rating score as the borrower has not built enough of a credit history) and will take what’s given since it is approved in six minutes, rather than weeks and does not require collateral such as a log book or title deed. In case you’re wondering whether Kabbage is a two-bit flash-in-the-pan player, it’s not. Since it launched in 2009 the company has lent more than $750 million (Kshs 75 billion) to small businesses and expected to lend $1 billion (Kshs 100 billion) in 2015 with revenue exceeding $100million (Kshs 10 billion).

The winner of this interest rate capping law is not the individual or SME borrower. Their risk profiles are such that they will be unattractive to lend unless a secure mechanism for quickly collateralizing and liquidating fixed and movable assets is put in place in Kenya. Such a system has to be backstopped by an efficient and incorruptible judiciary that will allow realization of securities to occur thereby reducing the drag currently endured by banks in liquidating bad debt. The true winner will be the fintechs that can very quickly dis-intermediate the banking system by providing credit to individuals and SMEs a) without collateral and b) within minutes. Timing is key in business, as it enables quicker turnover leading to conversion of goods into cash that is used to pay off the high-interest loan and put debt free funds into the pocket of the borrower.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

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Give your entire wealth to strangers

[vc_row][vc_column width=”2/3″][vc_column_text]I was in a recent discussion with someone who has just joined a not for profit organization whose area of focus is sexual reproductive health in Africa. Having sat on the boards of a few not for profit organizations, my curiosity was piqued regarding the source of funding for the organization’s programmes across various African countries. Said curiosity morphed into a question that yielded quite an interesting response. The organization is funded largely by American donors – the usual corporate suspects like Bill and Melinda Gates Foundation, as well as very many private individual donors. And that is what caught my attention: private individual donors who are inspired to gift while alive or bequeath post humously. What would inspire a right minded, manifestly talented individual who has created and multiplied wealth to just give it to absolute strangers, when the better option would be to keep it in the bank and let children and relatives salivate over the prospect of their inevitable death?

So I had to do a little research over this phenomenon, as this equatorial part of the world has yet to see widespread, unabashed and selfless giving at a time when amassing personal wealth has become a specialized race in the Kenyan corruption Olympics. I pulled up a Barron’s List of top 25 givers in 2013. Hang on to your hats, this was largely an American list of givers and the recipients were largely American institutions. Top of that list was – don’t hold your breath – Facebook founder Mark Zuckerberg and his wife Priscilla Chan who gave out $999.2 Million (in simple words, a billion dollars or Kshs 102 billion) of Facebook stock to charity. But not just any charity, they chose to give it to Silicon Valley Community Foundation which is a philanthropic clearinghouse, collecting charitable contributions and distributing them to hospices, educational groups, museums and clinics. I guess Mark and Priscilla figured: let’s give this money to a credible organization that knows how to better place these funds than we can. (Food for thought to be touched on later) Also on the top 25 list that year was Michael Bloomberg, the founder of Bloomberg, former New York City Mayor and 7th wealthiest man in the United States, who gave $452 million ( Kshs 46 billion) largely to his former alma mater, John Hopkins University, to fund scholarships as well as research. Actually a number of givers on that list gave money to their former universities; well run institutions that have demonstrated a great ability to efficiently channel donor funds into growing an established body of academic research and produce the nation’s greatest talented workforce.

Notably, Warren Buffett, chairman, CEO and largest shareholder of Berskshire Hathaway, holds the individual giving record. In 2015, Buffett donated $2.84 billion (Kshs 289.7 billion) of Berkshire Hathaway shares to the Bill and Melinda Gates Foundation as well as four family charities, three of which are overseen by his children. The purpose of donating stock is for the recipients to sell the same as appropriate and realize the cash value of the gift. The 2015 donation was his tenth annual one, bringing his total charitable donations to a staggering $25.5 billion (Kshs 2.6 trillion or 500 billion more than Kenya’s Kshs 2.1 trillion 2015/16 budget) according to Forbes Magazine. In case you missed it, Buffett is the fourth wealthiest man in the world and has pledged to bequeath 99% of his $64.5 billion net worth (or an eye-popping Kshs 6.58 trillion) to charity when he dies.

You don’t have to go far in Kenya to find battle lines drawn between brothers and sisters, mothers and children, uncles, aunts versus nephews and nieces all picking over the remains of an enterprising founder’s hard work like vultures over carrion. Something that these entrepreneurs know is guaranteed to happen, as there is always untidiness in the intestate death of a patriarch with multiple wives, multiple children and multiple beneficiaries of his largesse. It cannot be that one should work extremely hard over one’s lifetime: creating businesses, employing workers, enriching a supply chain and contributing to the taxman all for it to go belly up in lawyer’s fees and stomach churning blood feuds because we still subscribe to centuries old cultural succession practices that didn’t anticipate the kind of stupendous wealth that is at stake today. I’m not just talking about the ubiquitous Kenyan business magnate. I’m talking about you and I who have a few assets that may seem innocuous today, but which can be sold upon our death to generate a sum of money that would buy desks in a school, or a few hospital beds in a far flung medical institution, or pay for 50 pupils to get secondary education. Because our children have received the best gift from us, a good education which should put them in good stead to build wealth of their own instead of assuming the widespread sense of inheritance entitlement that I often observe from the children of the rich.
Now back to my earlier point about food for thought following the Zuckerberg contribution to the philanthropic clearinghouse. While our public universities and hospitals are crying for help, our record of funds mismanagement makes them poor candidates for direct gifting.

We lack an institution through which we can channel wealth for distribution to various worthy causes. An institution that is well-run, free from political interference, has perpetual succession and extremely strong governance mechanisms to ensure funds are appropriately and transparently used. Such an institution may provide an easy alternative to Kenyans who wish to leave their assets outside of family, as well as provide a mechanism to maneuver around the Kenyan laws of succession that require for dependents to be provided for, as one can gift one’s wealth while alive. Regardless of that, there are still many credible NGOs that can put our hard earned money to better use than some of our privileged children. Food for thought in 2016 and happy New Year to you!

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]