Tuesday 22 March 2011

More on "Beyond The Corporation"

From the lengthy thread following my earlier post on the book Beyond The Corporation:

I said: "The way I understand it, his argument is that the economy works far better if those 'super profits' are shared firstly between the providers of the actual money invested (as interest) and the remainder between all the employees."

Bayard countered: "What about the the providers of the actual money invested as share capital (as dividends)? People seem to be forgetting that, before every one's money was tied up in ridiculously expensive housing, business start-ups were financed through share capital, not loans from banks."

To focus thinking about all this, I find it helpful to distinguish between 'capital' (the value of the assets of the business, which could be financed by share capital, reinvested profits or new borrowing) and 'market capitalisation' (i.e. the total value of the company's shares in existence).

Let's take Tesco's 2010 financial statements as a nice simple example and round the figures a bit:

* 'Super profits' £2,336 m (we can safely assume that they buy and sell stuff at market value and pay market wages, so this is the surplus that arises from 'economies of scale' or 'synergies' or 'dominant market position' etc).

* Employees 472,000

* Net assets £15,000 m (broadly speaking, this is land and buildings £24,000 m minus net current/non-current liabilities of £9,000 m)

* The share capital side is £15,000 m (£5,000 m share capital and £10,000 m retained profits).

* We can contrast this figure with Tesco's market capitalisation of £31,000 m.

Questions

1. So what do we mean by 'capital'? Do we mean the value of the assets employed in the business of £15,000 m? Or do we mean the total value of Tesco's shares, which is slightly more than twice that £31,000 m?

2. Which capital is 'at risk' here - the £15,000 m or the £31,000 m?

Cluebat: If - like most accountants and solicitors, the very people who go round telling everybody else to incorporate and go for a trade sale or flotation* - the business were run as an LLP, the capital employed would clearly be £15,000 m. If all the employees were members of the LLP (and vice versa), they'd have an average partners' capital of £32,000 each and the average profit share (on top of market salary) for 2010 would have been £5,000 each.

3. Assume that Tesco were run as an LLP. Maybe next year will be a bad year, profits will halve to £1,200 m and each employee-member gets a bonus of 'only' £2,500. Would they consider their wealth to have been halved, or have they still become wealthier? How would this be different if this remains a quoted plc?

Cluebat: The market capitalisation of quoted plc's is broadly speaking a multiple of earnings, that multiple being decided by 'the markets' and being largely a function of factors outside the control of the business, i.e. interest rates. At present that p/e ratio happens to be 13.2. If profits were to halve, then all things being equal, the market capitalisation falls from £31,000 m to £16,000 m. So shareholders have suffered a 'capital' loss of £15,000 m, even though actually they made a current profit of £1,200 m.

4. Or maybe next year it will make a small loss of £500 m (or £1,000 per employee-member). How much has each of them lost - £1,000 or 'nearly everything'?

Cluebat: Let's assume that we expect those losses to continue for the foreseeable. If this were run as an LLP, the members would either radically re-shape the business or pull the plug, trying to salvage as much of their original £32,000 average stake as possible and they'd get two-thirds of it back (capital minus fire-sale losses, but no redundancy costs). However, Tesco is a quoted plc, so in this case, we'd expect the market capitalisation to fall to a break up value of (say) £10,000 million (i.e. £15,000 m minus a £500 m loss, minus redundancy costs, fire-sale losses and liquidator's costs), so outside shareholders only get a third of their money back.

* This phenomenon will be the subject of a separate post.

12 comments:

Lola said...

A modestly sized IT support business (in fact the one we use) has recently gone from Private ltd Co to LLP for this very reason. It's given the 'employees', who in reality are the main asset of the business a part of its success/failure. They are quite pleased about it, and I've noticed a better attitude from them.

Bayard said...

So an LLP is just like a Ltd Co, except that all the shareholders work in the business? Do they all have equal shares, are some more equal than others?

I wasn't really thinking about a company on the scale of Tesco, more about a younger, therefore smaller company where the original shareholders invested the money in that company in particular , not shares in general. I don't know about Mr Erdal's company, but in many family owned companies, all the shares are held by the family, who put up the money in the first place.

Mark Wadsworth said...

L, that's the general idea.

B, an LLP is a "limited liability partnership" i.e. it's a partnership but each partner (called 'member' for some reason that escapes me) has limited liability (so in that sense is the same as a company).

There is no need for members to work in the business or vice versa. The difference is there is not a level of entirely fictitious 'capital' called shares - with an LLP, each member gets a profit/loss share (and a salary if relevant) and has a capital account (being cash introduced plus salary/profit share, which he can withdraw in cash).

A member cannot 'sell' his share to outsiders, membership is infinitely divisible, profit share entitlements can be varied at will (and need bear no relation to the value of each members' capital account) and all in all, they are way cooler than Ltd companies (much better for tax as well, as it happens).

Mark Wadsworth said...

B, Mr Erdal's company was an old-ish family company (century and a half?), and one distant ancestor had put up the original money. The rest was reinvested profits. There was no 'market capitalisation' to speak of.

Anonymous said...

When a big buisiness makes £100 in what proportion is it divided employee/owner/gvmt

Mark Wadsworth said...

Anon, see previous post. I'd guess approx £37, £13, £50, but it's different for different businesses. Half of 'em get more money FROM the govt than they pay TO the government.

Bayard said...

"profit share entitlements can be varied at will (and need bear no relation to the value of each members' capital account)"

So who decides who gets what?

Robin Smith said...

"I find it helpful to distinguish between 'capital' (the value of the assets of the business,"

Most of a large corps assets are land or commonly created values, the return of which is rent. The return on capital is interest proper. Rent forms an ever larger fraction of the profits the larger the company becomes. Its called monopoly power. Not capitalism.

I dont mind what you call it, so long as you make it clear what you mean. Its not clear what you mean here.

Mark Wadsworth said...

B, that's the beauty of it. The members make it up as they go along.

It's a mixture of any or all of...

an outline agreement, which can be varied by a specified majority;

interest on capital accounts;

flat salaries or profit shares depending on how well your bit of the business did; and

the remaining profits/losses can be shared equally, proportional to capital account balances, number of years in the business or your shoe size.

Anonymous said...

That's interesting, I think most people would guess it was owner>employee>gvmt but it is gmt>employee>owner

Mark Wadsworth said...

RS, you're getting as bad as the Home-Owner-Ists. Just answer the question! What is the 'capital at risk' here - £15 bn or £31 bn?

(Ignore the fact that Tesco's 'capital' is mainly land and buildings and pretend it was all vehicles and plant and machinery if you so wish).

Mark Wadsworth said...

Anon, most people are wrong about most things. It is my job to educate people a bit.