From a classical economic perspective, the company and shareholder relationship can be viewed as an exchange of economic interests: a shareholder provides capital to a company today in exchange for the expectation of receiving that capital back plus a return on that capital at some point in the future. This view of company and shareholder relationships, however, ignores not only the reality of the ongoing relationship between shareholders and company management but also potential synergies between the company and shareholders and how those synergies can affect the economic interests of both parties. This article argues that through a broader view of the relationship between the company and shareholders it is not only possible to increase the likelihood that the shareholder’s expected investment return will be met, but also create additional company value and reduce company risk.

The Company and Shareholder Relationship

The classical economic view of the relationship between a company and a shareholder is an arm’s length exchange of equally valued economic rights and obligations. The shareholder provides a certain amount of capital to a company for an ownership interest in the company based on the company’s value. In exchange, the shareholder expects to receive their capital back plus a return on that capital reflecting the risk related to the investment. This view of the relationship between the company and the shareholder is narrowly focused on the points in time when the company receives the investment and the shareholders receive dividends and, of course, whether the parties’ economic expectations are met.

The classical economic view of the company and shareholder relationship is narrowly focused on the points in time when the company receives the investment and the shareholders receive dividends.

This view, however, ignores the reality that the relationship between companies and shareholders is not, either practically or economically, limited to discrete points in time when payments to each other are made. Particularly for private companies that ordinarily have a relatively small investor base, it is often an ongoing, interactive relationship. This relationship typically includes, at a minimum:

• the provision by the company of various financial reports to shareholders
• feedback by shareholders on the company’s strategy and operating performance, and
• voting by shareholders on different corporate matters.

Moreover, in addition to the typical channels of shareholder and company management communications, each of the company and its shareholders bring to the investment relationship a broad set of contacts, knowledge and experience which often have a great deal of potential economic value. The combined value of these assets can be significantly greater than their individual values.

For example, assume that one company has developed a soft drink that it currently only sells in Portugal. Let’s say that the value of its soft drink based on its current and expected sales is x. Similarly, assume that a company in China distributes soft drinks. The value of its distribution capability without the Portugues company’s soft drink is y. If the company China begins distributing the Portuguese company’s soft drink the economic value created may be significantly greater than the economic value of both businesses prior to the start of the economic partnership.

The relationship between a company and investors represents a field of economic potential that extends significantly beyond the exchange of funds.

Viewing the relationship between a company and a shareholder as a flexible value field rather than limited to discrete exchanges of funds is useful because it highlights the reality that company and shareholder relationship economic potential is negative as well as positive. Companies and shareholders each create economic risks for the other party. A company may take actions that are adverse to the shareholder’s economic interests and damage the shareholder’s reputation. A shareholder may frustrate company objectives and make it difficult for the company to operate. This damage can be significantly in excess of the amount of the original investment and expected return.

Company and Shareholder Synergies

There are many areas of synergies between shareholders and companies that are in the economic interests of shareholders as well as companies to consider and maximize. The following are the key areas of these synergies.

Shareholders and Company Strategy. The first area of synergy between shareholders and companies is the area of strategic analysis. Many shareholders invest in companies because they are familiar with the company’s sector, understand the opportunities and risks the company faces and are in a position to provide useful feedback on company strategy and operations. While of course the degree to which a company ultimately follows the views of certain shareholders depends on the shareholder’s ownership interest in the company, the merits of the shareholder’s strategic input and how the shareholder’s strategy views fit in with the company planned allocation of its resources, involving shareholders in the strategy formulation process is often a very good way to improve the company’s strategic direction or at least draw management attention to looming strategic risks.

Shareholders and Operational Oversight. The second area of synergy between shareholders and companies is operational oversight. There are often significant differences from one company to the next regarding the extent of the shareholder’s role in ongoing company operations. In some companies, the shareholders have very little if any involvement in company day-to-day operations while in others the company’s organizational documents provide for very structured forms of shareholders participation in company affairs and company oversight. Independent of the company’s organizational documents, informal relationships between company management and shareholders can take many different forms. The nature and quality of shareholder oversight of company operations and how differences of opinion that arise along the way are handled can significantly affect company value.

Particularly for companies that are early stages of growth, shareholders with extensive operational experience can provide valuable insights to help the company to avoid operational pitfalls.

Shareholders as Business Partners. The third area of synergy between shareholders and companies is as potential business partners. Many companies who are fundraising seek out “smart capital”, meaning investors who can contribute more to a company than merely passive capital. Smart capital can have many elements including, apart from potential strategy support and operational oversight, IT, support in creating business relationships with third parties or even options for parallel business projects.

The ability of a company and shareholders to develop new business together is a highly valuable option.

Shareholders as Sources of Additional Capital. Similar to the adage that your current client is often your best future client, current investors can be an excellent source for future capital that the company may need. Because many investors have relationships with a company for a significant period of time, they are often in an excellent position to see the strengths of the management team and potential opportunities for additional growth. This means that if the investor forms a positive view of the company’s performance it may invest additional money in the company or recommend that other investors do so. Even if an existing investor does not invest further capital in the company, it may recommend that other investors it has a relationship with do so.

Strengthening Company and Shareholder Synergies

There are several ways for companies to identify, development and take advantage of potential synergies.

Ongoing Review of Business Objectives. Neither companies nor shareholders are static economic entities that remain the same over the course of an investment period; each of them grows, gains experience and reacts in light of changing market conditions. For this reason, it is important for companies and shareholders to jointly continually review their respective objectives, consider how those objectives overlap and examine what possibilities there might be for jointly creating additional value.

Joint New Business Planning. There is of course a large difference between identifying synergies that exist in the abstract and actually creating and implementing a plan to put those synergies into effect. If a shareholder has IT that can be used to further support the company’s business or be used as the business for a new business area, the parties must work through the issues of:

• how the technology will be used
• what the advantages and disadvantages are of using the technology
• the technology implementation time frame and budget
• the expected economic impact of implementing the technology and
• how economic benefits will be distributed between the parties.

Shareholder Reporting. A key element for strengthening company and shareholder synergies is a robust reporting process. Rather than simply providing a summary of economic results, the purpose of reporting should be to discuss how the market is impacting the company’s strategy and how the company intends to react to that impact.

Rather than simply being used to report results, shareholder reporting should be used to more broadly discuss market trends, company strategy and the advantages of disadvantages of different strategic courses of action.

Providing more robust reporting gives an investors much better insight into opportunities and risks at an early stage and more opportunity to help take advantage of these opportunities or avoid these risks. Simply providing results after the fact is often too late for the shareholder to affect the business outcome.

Moreover, particularly if shareholders are kept in the dark about negative conditions it may cause them to lose faith in or adopt an adversarial position against the management team, which can increase the likelihood of a further loss of company value. This can become a very damaging downward value spiral. Conversely, if investors are early informed of negative business conditions or the possibility of the company’s missing business targets, even if investors do not play an active role in the solution, they have the opportunity to see up close the steps the company is taking to remedy the issue or at least mitigate the consequences. In many business situations, the actions of management serve to save a negative situation from turning even worse. This is a value savings for investors that often is harder for them to appreciate if they are left out of the picture.

Conclusion

Viewing the company and investor relationship as an ongoing area of economic potential rather than merely fixed points of economic exchange can lead to a great deal of value creation for both parties. Taking this perspective, analyzing potential synergies and mapping out plans to take advantage of them can make it more likely that company value is increased, the investor meets their investment return, investment risk is reduced and new business opportunities are generated.