Is the “Smart Money” Right This Time?
Public companies are rushing to the bond markets to raise cash to pay “special dividends” before December 31, 2012. The rush is on to beat the train of expected rising dividend taxes in 2013.
Some companies (like Apple and Microsoft) don’t need to go to the bond markets because they have enormous amounts of cash already. Apple has $30 billion of cash (or if you include “long-term” investments, close to $100 billion), and Microsoft has $51 billion.
Microsoft paid a special dividend in 2004 of $32 billion, and there are rumors that another is forthcoming before year-end. The rumors apply to Apple, as well. Interestingly, many announcements of special dividends are followed by significant stock price increases. And loads of other companies have already or will pay special dividends by year-end.
Why would a company’s stock price increase? Isn’t the business devalued by the amount of cash paid? Surprisingly, stock prices quite often increase following special dividends. It might be the public markets’ appreciation for proper treatment of shareholders, or the expectation that one smart board decision might be followed by others?
The so-called “smart money” is rushing to pay special dividends to reward shareholders and to avoid expected increases in taxes on dividends in 2013. Maybe they are getting it right this time.
What About Your Closely Held or Family Business?
Public companies tend to hire lots of MBAs who are well-versed in corporate finance theory and practice. Their managements and boards are exposed to public securities analysts and institutional investors who are also familiar with corporate finance. Many, if not most, private companies don’t think in terms of corporate finance in the way that public participants do. But the same rules of value creation and shareholder returns apply in both the public and private markets.
The following word picture may generally describe your company or it may be highly descriptive. In any event, read this word picture and think about your situation, that of your company, and of your other shareholders, whether they are family members or not.
- Your company has been successful over a period of several or many years.
- You have never paid significant dividends, or likely, have never paid distributions except for taxes for pass-through entities. If your company has paid dividends, they have been irregular or stingy or both.
- You have come through the recent recession and are accumulating cash and/or reducing debt.
- Your bankers are quite interested in loaning money to you — after all, you don’t need it!
- You may be looking for a significant investment opportunity, which is your reason for accumulating cash, but things are pricy and you are choosy. The bottom line is that large acquisitions are risky and you will be sure to take your time. In the meantime, the cash machine which is your business keeps on running.
- As you deleverage, your company’s return on equity is decreasing. That means that your shareholders’ returns are decreasing.
- You have had the philosophy of keeping all of your eggs in your company’s basket and watching that basket very closely. As a result, you and your major shareholders have most of your collective net worth tied up in the company. This philosophy has worked for years, so why change now? Well, read on.
- Things have gone well for a long time, and you don’t feel there are significant risks to your business. That’s why you don’t pay dividends and why you keep your fortune tied up in the business. Unfortunately, you are probably wrong about the risk assessment. Bad things can happen to even really good companies. And when bad things happen unexpectedly, the picture changes and options are diminished, often drastically. There is a reason why financial planners admonish their clients to diversify their wealth.
- But still, you don’t want the kids to receive a windfall, or for goodness sakes, those nonworking owners as well. However, you can’t control everything, and you are the custodian charged to deliver satisfactory returns to all of your shareholders.
- You read about the “special dividends” being paid by public companies and somehow think that their motivations are not relevant for you and your private company. They are.
If you have read this far and the word picture painted fits your circumstances, let me recommend that you consider implementing a special dividend prior to December 31, 2012. The rules of corporate finance apply to private businesses as well as public companies. If you lack adequate growth opportunities, your best “investment” may be a special dividend to your shareholders.
Some companies could pay a dividend equivalent to 10%, 20%, or even 30% of their current market values. The ability to pay will depend on your current balance sheet position, your relationships with your banks, and your own ability to think outside the historical box that has helped you become so successful. Perhaps now is the time to give it a try.
And don’t worry about the value of your business going down following the special dividend. Even if it did go down dollar for dollar, you have traded a dollar of illiquid wealth for a dollar of liquid wealth (less a bit of tax). The diversification opportunity is worth the small tax bite from the dividend.
Please do get appropriate tax, legal and financial advice before you do!
Do Something Now
Call me or your trusted financial adviser(s) today. Ask your financial planner what he or she thinks about a little diversification.
Read The One Percent Solution. I wrote it. Page 12 notes the following about special dividends:
Sometimes, companies that have been reluctant to pay dividends but, nevertheless, generate more cash from operations than
needed to support those operations, and allow assets to accumulate on their balance sheets. Think of such assets as “excess assets” not needed for normal business operations. This is a good idea, because they provide a nest egg for a rainy day, right? Wrong. Excess assets dampen shareholder returns, give management a false sense of security (i.e., misplaced “comfort”), and prevent or delay shareholder diversification.
A dose of leverage, prudently applied, can also be considered. The One Percent Solution is a quick read and it is complimentary. Read it and consider its suggestion of special dividends. There are a number of other things that you can consider, as well.
Again, the so-called “smart money” is rushing to pay special dividends to reward shareholders and to avoid expected increases in taxes on dividends in 2013. Maybe they are getting it right this time and so can you.
Don’t look back in January 2013 and think that you didn’t do anything wrong. In this case, not doing something could be the wrong thing.