Creating a SUSTAINABLE Family Business
July 2, 2010
By Wayne Rivers
Consulting giant McKinsey produced a paper called “The Five Attributes of Enduring Family Businesses” earlier this year, and the content was widely discussed and circulated. They noted that one-third of the companies in the S&P 500 and 40% of the 250 largest companies in France and Germany are family businesses; as our readers know, the term “family business” does not necessarily mean “small business.” While many of the conclusions they drew were applicable only to the largest multi-generation companies, there are valuable lessons that apply to family businesses of all sizes and types. In this article, we’ll lay out McKinsey’s key success attributes along with FBI’s comments and critiques.
McKinsey’s authors write: “As family businesses expand from their entrepreneurial beginnings, they face unique performance and governance challenges. The generations that follow the founder, for example, may insist on running the company even though they’re not suited for the job. And as the number of family shareholders increases exponentially generation by generation, with few actually working in the business, the commitment to carry on as owners can’t be taken for granted. Indeed, less than 30% of family businesses survive into the 3rd generation of family ownership.
“To be successful as both the company and the family grow, a family business must meet two intertwined challenges: achieving strong business performance and keeping the family committed to and capable of carrying on as the owner.”
The number of family members owning or working in the business DOES NOT, in fact, increase “exponentially generation to generation.” Perhaps seeing the challenging handwriting on the wall, most family businesses produce, every generation or two, one or more strong entrepreneurs who understand that too many cooks in the kitchen spoil the pie. These leaders step up to the plate, initiate healthy dialogue about direction and governance, and put their dollars where their mouths are by buying out family members who may be looking to divest or who don’t share their future vision. The shape of the family ownership tree is not usually an ever-expanding pyramid, but rather a diamond shape with a consolidation of ownership every other generation or so. This is, of course, a generalization, but the pattern tends to be quite common.
McKinsey writes: “Family businesses can go under for many reasons, including family conflicts over money, nepotism leading to poor management, and infighting over the succession power from one generation to the next. Regulating the family’s roles as shareholders, board members, and managers is essential because it can help avoid these pitfalls. Large family businesses that survive for many generations make sure to permeate their ethos of ownership with a strong sense of purpose. . . . Long term survivors usually share a meritocratic approach to management.”
We concur wholeheartedly. Merit should outweigh nepotism without question. The payoff can be immense. As we wrote in The Family Business Advisor in March, 2008, “business focused families” create $6.2 of net worth for every dollar of net worth created by “family focused families.” (Click to read the article) Everyone wins when merit is the main determinant.
McKinsey writes: “Maintaining family control or influence while raising fresh capital for the business and satisfying the family’s cash needs is an equation that must be addressed since it’s a major source of potential conflict, particularly in the transition of power from one generation to the next. Enduring family businesses regulate ownership issues – for example, how shares can (and cannot) be traded inside and outside the family – through carefully designed shareholder agreements which usually last for 15 to 20 years. . . . Because exit is restricted and dividends are comparatively low, some family businesses have resorted to ‘generational liquidity events’ to satisfy the family’s cash needs. One chairman said of his company, ‘Every generation has a major liquidity event, and then we can go on with the business’.”
This type of transition only happens once a generation, but there is never a good time for it. Either the business is booming, and so it needs capital to grow, or the business is in decline, for example in a recession, and the business needs capital to survive. If you don’t plan for the inter-generational transition and the exit needs of departing family members, then it is quite difficult to raise that kind of capital in the short run and not have it negatively affect business operations. Creating a sufficient rainy day fund to cash out departing owners – irrespective of their generation – is just smart business.
McKinsey writes: “Family businesses, like their non-family peers, face the challenge of attracting and retaining world class talent to the board and to key executive positions. In this respect they have a handicap because non-family executives might fear that family members make important decisions informally and that a glass ceiling limits the career opportunities of outsiders.”
Interestingly, one of McKinsey’s earlier research findings actually notes a significant advantage that small companies have in attracting top talent. Big companies today find themselves competing for executives with entrepreneurial organizations. An executive at AlliedSignal said, “We’re competing with start-ups, not General Electric.” When we seek talent at The Family Business Institute, we always ask the question, “Why would you want to work for a small company like ours when someone with your talent, background, and resume could go work for virtually any Fortune 500 business?” The answer almost always points to one thing: impact. Today’s talented executive wants to be in a role where they can directly see the impact their effort produces. That’s sometimes very hard to do when you’re simply a cog in a great machine. In a company with only 50 or 500 employees, impact is much easier observed than in a massive organization.
McKinsey writes: “Too much prudence can be dangerous. Family owners, who usually have a significant part of their wealth associated with the business, face the challenge of preventing an excessive aversion to risk from influencing company decisions. Excessive risk aversion might, for example, unduly limit investments to maintain and build competitive advantage and diversify the family’s wealth.”
In the state of today’s economy, it is easy to look back at decisions which didn’t pan out and say the business leaders were operating in too risky a fashion. But that’s 20-20 hindsight; much more common is the family business that is risk averse and becomes bogged down in the infamous “deciding not to decide” mode. This inevitably means the business stagnates over time, plateaus in growth and profits, and is bypassed by hungrier competitors. To paraphrase the late J. Paul Getty on how he made business decisions, he said he looked at a business deal, figured out what the ultimate downside was, and if the downside risk of the deal could kill him, he wouldn’t do it. Otherwise, he would enter into the deal. While that may be a little too stark for some owners of family companies, that is probably a healthier attitude toward business risk than the myopic risk aversion in many family enterprises today. Family businesses must periodically RENEW and REINVENT themselves if they want to be sustainable over the generations.
While the McKinsey paper has to do mostly with mega-wealthy 3rd and 4th generation family businesses, there are lessons for small to medium enterprises as well. After all, isn’t it everyone’s goal to have their businesses grow to a point where they are sustainable and enduring over the years? Family businesses – even in a period of extreme economic dislocation – must be on the lookout for ways to formalize and professionalize their processes and decision making. Failure to do so will bog down the family business – especially at transition time – in misunderstanding, bickering, infighting, and potentially fracturing the family that spawned the business.
The Family Business Institute, Inc.
Wayne Rivers is the president of The Family Business Institute, Inc. FBI’s mission is to deliver interpersonal, operational and financial solutions to help family and closely-held businesses achieve breakthrough success. Wayne can be reached at 877-326-2493,firstname.lastname@example.org, or on the web at familybusinessinstitute.com.
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