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Chapter One.

The Nature, Importance, and Uniqueness of Family Business

The Three Generation Rule

  • Grandparents start the company
  • Children run the company
  • Grandchildren rarely see a dime

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Course Goals

  • Gain an understanding and respect for the challenge of family-business continuity
  • Understand better the challenges and advantages faced by your own family business
  • Learn managerial, governance, and family best-practices that increase odds of family-business success

Family Business: Working Definition

  • A family business is a synthesis of:
  • Ownership control (15%+) by two or more members of a family or a partnership of families
  • Strategic influence by family members on the management of the firm
  • Concern for family relationships
  • The dream (possibility) of continuity across generations

When does an entrepreneurial company become a family business?

Typically when the next generation – “the kids” join the business within ten years of having graduated from college.

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Examples of Family Businesses

  • Ford Motor Company
  • The New York Times
  • The Washington Post
  • Bigelow Tea
  • Marriott Ritz-Carlton Hotels
  • Inditex/Zara
  • L. L. Bean
  • Gap
  • Timken Steel and Bearings
  • Salvatore Ferragamo
  • Miele Appliances
  • Toyota
  • El Nuevo Día Newspaper

Wall Street Journal

  • Levi Strauss
  • Kohler
  • Nordstrom
  • Hermés
  • Wal-Mart
  • Cemex
  • SC Johnson
  • Samsung

Family Businesses…

  • Constitute 80–98% of all businesses in the world’s free economies
  • Generate about 49% of the GDP in the U.S. and more than 75% in most other countries
  • Employ about 80% of the U.S. workforce and more than 85% of the working population globally
  • Create about 85% of all new jobs in the U.S.

Family Firms Outperform

  • Family-controlled firms in the S&P 500 achieved 53% greater economic value added than their management-controlled counterparts
  • Family-controlled firms had a 6.65% greater return on assets (in EBITDA terms)
  • Family firms created an additional 10% in market value during the 1992–1999 period

Source: Anderson, R., and Deeb, D., Journal of Finance, July 2003.

  • Family firms exhibit stronger commitment to philanthropy than their non family counterparts. They also tend to engage in “strategic philanthropy”, the focused, high impact philanthropy that the William and Melinda Gates Foundation practices.1
  • Family foundations represent 55.5% of the 200 largest foundations in the US and 56% of the annual giving ($1billion).2

1 Family Business Review, in press, 2012.

2 Family Business Review, in press, 2012.

Ethics, Philanthropy, Environment and CR

Other Statistics

  • A full one-third of all Fortune 500 companies are family-controlled, and about 60 percent of all publicly traded firms remain under family influence

Other important differences

  • Average tenure of the CEO is 18 years versus 18 months to 3 years for the average CEO of an S&P 500 company
  • Average share holding time is a generation vs. 9 months in Fortune 500 companies1
  • 24 percent of family businesses surveyed have a female CEO or President. 2 This far outstrips the 2.5 percent of Fortune 1,000 firms which are led by women.3
  • Family businesses aspire to continue across generations of owners or owner-managers

1 Bain & Co., C. Zook, 2007.

2American Family Business Survey, Mass Mutual/Kennesaw State/FFI, 2007.

3Fortune Magazine, April 20, 2007.

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What Makes Family Business Different

  • The presence of the family
  • The owner’s dream to keep the business in the family
  • The overlap of family, ownership, and management
  • The competitive advantage derived from this interaction

Succession and Continuity

  • The most prevalent reason why family-owned and family-controlled companies fail relates to a failure in succession planning
  • Three patterns of ineffective succession were identified in one study:
  • Conservative
  • Rebellious
  • Wavering

Building Family Businesses That Last

  • Takes ongoing dialogue (talking) across generations of owner-managers about their vision for the company
  • Family businesses that have been built to last recognize
  • the tension between preserving and protecting the core of what has made the business successful
  • and promoting growth and adaptation to changing competitive dynamics

Family Business Theories

  • Systems theory
  • Agency theory
  • Resource-based theory
  • Stewardship theory

Systems Theory

  • The firm is a dynamic system in which integration is achieved by adjustments between family, management, and ownership subsystems
  • Individual perspectives of family and firm may differ, leading to overemphasis on one sub-system at the expense of others

The Systems Theory Model

Family Members

Other Shareholders

Family Shareholders

Owner-Manager Family Members

Owner-Managers

Family

Employees

Non-Family Managers & Employees

Source: The Systems Model. Adapted from Davis and Tagiuri, 1981.

Family

Management

Ownership

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Family-First Businesses

  • Employment in the business is a birthright
  • Members of the same generation are paid equally
  • Perks that transfer from the business to family members are often extensive
  • Financial systems are hidden and secrecy is often paramount
  • Commitment to continuity depends on the agendas of individual family members

Management-First Businesses

  • Employment is on the basis of qualifications—family is discouraged from working in the business
  • Performance of employed family members is reviewed in the same manner as the performance of nonfamily managers
  • Compensation is based on responsibility and performance
  • Conversation between family members is usually all business

Ownership-First Businesses

  • Investment time horizons and perceived risk are the most significant issues
  • Often have shorter time frames within which financial results are evaluated
  • Not much long-term thinking

When Things Get Messy!

  • Boundaries among family, ownership, and management systems may become blurred
  • Problems determining if decisions relate to family, ownership, or management issues
  • Family rules may overtake the business
  • Problem-solving ability diminished by blurred boundaries

Too Much Pain?

  • According to Forbes magazine, the family business has four options:
  • Sell
  • Merge with another
  • Shut it down
  • Stay the same and call Dr. Phill

Available at www.forbes.com/sites/aileron/2013/07/31/the-facts-of-family-business/

Deal With The Pain

  • If things stay the same, the family has hard decisions to make.
  • Who leaves the company?
  • Should senior family members pass the torch?
  • Hire professional manager?
  • How do we implement?

www.forbes.com/sites/aileron/2013/07/31/the-facts-of-family-business/

Joint Optimization Alternative (Best)

  • Family employment policy
  • Not all family members are employees; some are responsible shareholders
  • The performance reviews are the same for everyone
  • Family members are encouraged to get experience
  • Everyone has a commitment to family business continuity

Agency Theory

  • Traditional theory: the natural alignment of owners and managers decreases agency costs of ownership in family firms
  • Recent research: the altruism of owner-managers leads to increased agency costs
  • Choosing less risk
  • Or, choose poor business decisions
  • Agency costs can be controlled by policy and practice
  • A Board of Directors is important in monitoring managerial behavior and controlling costs

The Strategic Perspective: Competitive

  • Shrinking product life cycles
  • Intense cost competition
  • Diesel fuel
  • Beef costs?
  • Rapid change in distribution and value chains aside from block-chain
  • Increasing individualism of younger generations
  • The entrenchment of the current-generation CEO

Resource-Based Theory

  • Resource-based theory highlights unique capabilities or resources that family firms convert into competitive advantage
  • These resources/ capabilities are often referred to as organizational competencies
  • The ability of a particular family business to capitalize (leverage) on its unique advantages depends on the quality of the interaction between business and family

Core Competencies to Competitive Advantage

  • Concentrated ownership structure may lead to higher overall corporate productivity and longer-term commitment to investments in people and innovation
  • The nature of the family–ownership–management interaction, family unity, and ownership commitment may:
  • Support patient capital, lower administrative costs, skills/knowledge transfer across generations
  • Provide agility in rapidly changing markets
  • Focus on quality, customers, and higher returns
  • Protect the company (family) name

Stewardship Theory

  • Claims that founding family members view the firm as an extension of themselves. Therefore, view the continuing health of the enterprise as connected with their own well-being
  • Owners inherit a responsibility to others, to stewardship, so that the enterprise they received from the earlier generation may successfully pass on to the next
  • As stewards of the firm, family owners often place individuals on the board that can provide objective advice and advocate for a going concern
  • The independence of the board has a positive impact on the financial performance of the firm through its advisory role more than through its monitoring or supervisory function

Lower Overall Costs

  • Cost of capital is very low when the business owner controls stock
  • Financing for other businesses:
  • 25–30% for venture capital
  • 17–20% for mezzanine financing
  • Prime rate for bank financing, plus risk, plus underwriting
  • The overlap between owner and manager allows family-owned businesses to enjoy lower administrative costs because of lower CEO compensation, reduced levels of supervision, and reduced investment in financial systems and controls

Source: deVisscher, F., “When shareholders lose their patience,” Family Business Magazine, Autumn 2000; and Gomez-Mejia, L., Larraza-Kintana, M., and Makri. M., “The determinants of executive compensation in family-controlled public corporations,” Academy of Management Journal.

Agility and Flexibility

  • The greater flexibility of new manufacturing and distribution-retail-service technology makes smaller runs economically attractive
  • Customization, changing consumer preferences, and shorter product life cycles reward agility
  • EDI/Internet-based partnerships in the supply chain make agility possible across value chain

Source: Poza, E., “Look who’s out there on the cutting edge.” Family Business Magazine 4 (1), Winter 1993.

Patient Capital and
Long-Term Perspective

  • Average tenure of 18 years for owner-managers (vs. <8 years for public company CEOs) is correlated with commitment to making efficient long-term investments in the family business
  • The company continually optimizes the mix among family, management, employees, customers, and ownership for higher long-term profitability

Source: Daily, C. and Dollinger, M., “An empirical examination of ownership structure in family and professionally managed firms,” Family Business Review 5 (2), 1992; James, H., “Owner as manager, extended horizons and the family firm,” International Journal of the Economics of Business 6 (1), 1999; and Adapted from Waterman, Robert H., Jr. What America Does Right. New York: W. W. Norton and Company, 1994.

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