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Warren Buffett’s Risky Final Bet

19th June 2016 Josh Baron & Rob Lachenauer, BanyanGlobal

Great philanthropy becomes a legacy question for founders. Where do you want to leave your real mark – in your philanthropy or in your business?   But is there a risk?

Throughout his great career, Warren Buffett has made huge bets – for example, investing billions in Goldman Sachs during the financial meltdown of 2008. But as shareholders gather in Omaha for the Berkshire Hathaway Annual Shareholders meeting on April 30, they ought to be thinking about Buffett’s biggest bet.

The altruistic capitalist has pledged to donate 99% of his fortune, which is held primarily in Berkshire stock, to philanthropic causes, largely through the Bill & Melinda Gates Foundation.

Mr. Buffett’s extraordinary generosity (his Berkshire wealth is estimated to be worth $66.4 billion) will help to improve education, enhance healthcare, and reduce extreme poverty – a huge boon to societies around the globe.

But that generosity may undermine a pillar of Berkshire Hathaway’s success – namely, Berkshire’s ownership structure and, with that, control of the company. Buffett is betting his largesse will not undermine the very strategy and culture that has been the basis of the iconic company’s long-time success.

That’s a big gamble.

Berkshire stock is publicly traded, but because of the size of their shareholdings, Warren Buffett and Charlie Munger are, “for better or worse” (as Warren Buffett has written), the “controlling partners.” Between his Class A and B shares, Buffett has 33% voting power over Berkshire Hathaway today.

As he gives his shares to the Gates and other foundations, which he started doing in 2006, ownership control will – over time but inevitably – be dispersed to many owners.

Just follow the shares.

Last year, Buffett gave 20.64 million Class “B” shares of Berkshire to five foundations, his largest contribution ever, increasing his total donations to more than $21.5 billion of Berkshire stock since 2006. All private charitable foundations face stiff penalties under the tax code unless they give away a percentage of their assets annually. Private foundations that are primarily funded with shares typically sell some in the open market to meet their obligations and charitable objectives. What’s more, most foundations follow prudent investment policies mandating that portfolios be diversified.

As a consequence of the inevitable liquidation of many Berkshire shares in the years after Warren Buffett’s donations, control of Berkshire is likely to end up diluted, as it is for other publicly traded companies. This move away from concentrated ownership raises questions about the company’s future. As the balance of power shifts from owner-managers to outside investors, will there be a greater focus in Berkshire on quarterly results? Will activist investors push for the company to be broken up? Will Berkshire’s distinctive strategy change as Berkshire shifts from a publicly traded partnership to a truly public company?

Given what we know from publicly released information, Warren Buffett has weighed (and dismissed) some of the consequences of his philanthropy on Berkshire after his passing. As he said in a 2006 interview with Fortune, “I would not be making the gifts if they would in any way harm Berkshire’s shareholders. And they won’t.” But Buffett was talking about how his philanthropic gifts would affect Berkshire’s stock price at the time. Our point goes deeper: What happens to the essence of an owner-controlled company when the owner/founder is gone? (We asked Berkshire to comment on this question; it declined.)

For many years, investors have speculated on what will happen to Berkshire when Buffett dies – but they tend to focus on who will succeed him as CEO, and what will happen to the stock price. Buffett insists the company has a solid succession plan in place; at last year’s annual shareholder meeting, he announced that after his death, his son, Howard Buffett, will become the unpaid non-Executive Chair of the Board to ensure the continuation of Berkshire’s unique culture.

Will Howard Buffett be able to fulfill the role of the values champion who defends his father’s legacy in the face of challenges to Berkshire’s strategy and values? We suspect not – not because of any shortcomings, but because he will not have the shares to back him up.

Here the experience of Hewlett-Packard (HP) offers a cautionary tale.

In 2001, then-CEO Carly Fiorina recommended to the board the acquisition of Compaq Computer. The deal was a watershed moment in the company’s history, and family shareholders, in particular board member Walter Hewlett – the son of co-founder Bill Hewlett – vehemently and publicly disapproved of the acquisition. In response, HP very openly dismissed Walter Hewlett as a mere “musician and academic,” prompting the Hewlett heir to put out angry national prints ads saying: “A $25 billion mistake is not the HP Way.”

But power follows the shares. By giving his shares away to The William and Flora Hewlett Foundation, among others, HP co-founder Bill Hewlett laid the groundwork for his son’s inability to block a move by management that ran counter to the founders’ core strategy. Even with help of the Packard heirs, the Hewlett heirs were unable to block the Compaq deal. The founders’ descendants lost a proxy battle 48% to 52%. And Walter Hewlett turned out to be right: the deal has turned out badly, and the company’s performance has suffered.

Great philanthropy becomes a legacy question for founders. Where do you want to leave your real mark – in your philanthropy or in your business? There is no one right answer. There is simply a choice to be made, and both decisions have consequences.

Bill Gates, co-founder of Microsoft, has clearly selected the Gates Foundation to be his platform. After he set up that foundation in 2000, Bill Gates has steadily scaled back his involvement in and ownership of Microsoft, stepping down as chairman in 2014. His legacy, he has said, will be to “help every person get the chance to live a healthy, productive life.”

Gates has not only committed his vast wealth to philanthropic causes, but – along with Buffett – has started a movement to encourage other billionaires to do the same. Almost 150 families have taken this “Giving Pledge,” many of whom are the founders of celebrated companies such as Intel, Oracle, and Virgin.

These billionaires are held up as great philanthropists who both change the world and inspire others to give more. But the giving pledge has not been without its critics, including by those who argue that there are better ways to do philanthropy. An alternative approach, for example – but one less likely to make headlines – is when founders try to preserve their businesses as great institutions.

With many of these companies – Cargill, Bechtel, SC Johnson, among others – family members own the company and oversee its long-term success. They also often inherit a deep sense of responsibility for their business and to their communities and are frequently, as individuals, deeply committed to philanthropy. In these instances, charitable causes are funded via annual distributions rather than splashy transfer of ownership. This can be a highly effective way of giving, and at the same time, these family members retain the benefits of closely held ownership, something that Berkshire Hathaway will lack.

Warren Buffett’s bet is that he can have it both ways. He is deeply committed to becoming one of the great philanthropists of all time. But he hopes simultaneously to perpetuate the success of Berkshire after his death. As he said when asked what giving shares to the Gates Foundation meant for Berkshire: “I’d say virtually nothing…The name on the stock certificates will change, but nothing else will.”

We worry this is the wishful thinking of a founder who has birthed a legendary organization that he hopes will last forever. In our experience, no amount of brilliance on Buffett’s part can overcome the fundamental reality of the ownership transition at Berkshire Hathaway that has been set in motion.

Time will tell if his gamble pays off. Meanwhile, other founders considering extraordinary acts of philanthropy similar to Warren Buffett’s would do well to keep a close eye on Berkshire Hathaway. Can you give away your billions without giving away your company? If Warren Buffett can’t beat the odds, we wonder if anyone can.

About the Authors - Josh Baron is a Partner and a co-founder of Banyan Family Business Advisors, and author of the forthcoming book Great Power Peace and American Primacy: The Origins and Future of a New International Order. Rob Lachenauer is the CEO and a co-founder of Banyan Family Business Advisors, as well as co-author, with George Stalk, of Hardball: Are You Playing to Play or Playing to Win?  This article first appeared in the Harvard Business Review and has been reproduced with the authors permission.  To find out more please visit their website here

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