The best course

The Smart Manager - - Contents -

John Col­ley, War­wick Busi­ness School, tells us how fam­ily-run busi­nesses of­fer many valu­able lessons to cor­po­ra­tions—from se­lect­ing lead­er­ship to cre­at­ing share­holder value.

In a 2014 ar­ti­cle in The Smart Man­ager, Pro­fes­sor John A Davis, Har­vard Busi­ness School, ob­served: fam­ily busi­nesses are long term-ori­ented or­ga­ni­za­tions that prom­ise bet­ter sta­bil­ity in terms of own­er­ship and lead­er­ship. There is a lot of pas­sion to ex­cel and also per­sis­tence, which in­vari­ably lead to bet­ter per­for­mance. 1 True, fam­ily busi­nesses serve as a repos­i­tory of man­age­ment lessons even while fight­ing vul­ner­a­bil­i­ties such as fam­ily feuds, gen­er­a­tional di­vide, and di­verse busi­ness goals.

Re­search find­ings show that large, long­stand­ing, pub­licly traded fam­ily busi­nesses grow faster than non-fam­ily ones. They are more re­silient, 2 and out­per­form mar­ket re­turns by sev­eral per­cent­age points. Across the eco­nomic cy­cle, av­er­age long-term per­for­mance was higher for fam­ily busi­ness than non-fam­ily busi­ness. Fam­ily busi­nesses per­formed bet­ter dur­ing re­ces­sions, and less well dur­ing good eco­nomic times. Over­all, they carry less debt and in­vest less in cap­i­tal ex­pen­di­ture, R&D, and ac­qui­si­tions. Re­search also shows that CEO ten­ure in fam­ily busi­nesses is sev­eral years longer. Hence, out­per­for­mance is ac­com­pa­nied by a num­ber of quite spe­cific traits, which may pro­vide valu­able lessons for oth­ers. Why are these traits ben­e­fi­cial and what can be learnt from them?

Fam­ily-owned busi­nesses form a crit­i­cal part of any econ­omy. They ac­count for 80% of com­pa­nies world­wide and con­sti­tute the largest source of em­ploy­ment in most coun­tries. In the US, they em­ploy

3 60% of work­ers and whilst many are small they also make up one-third of S&P com­pa­nies. In East Asia

4 and Latin Amer­ica, they con­sti­tute around 60% of firms and in Ger­many and France, they are around 40% of the largest firms. Whilst they make up the pre­dom­i­nant form of busi­ness, their ap­proach does con­trast with the more con­ven­tional listed busi­ness and in­deed those with fi­nan­cial own­ers. There is plenty for all to learn from suc­cess­ful fam­ily busi­nesses. In re­cent years, there has been more re­search in this pre­vi­ously ne­glected area, which helps iden­tify what suc­cess­ful fam­ily busi­ness does well.

align­ment of share­holder and man­age­ment in­ter­ests

First of all, fam­ily busi­nesses are nor­mally run by the own­ers; so, share­hold­ers and man­age­ment are tightly aligned on ob­jec­tives. In a pub­lic-listed busi­ness, this is a per­pet­ual prob­lem as boards fre­quently run the

busi­ness for their own in­ter­ests rather than those of the share­hold­ers. This is of­ten demon­strated through CEOs giving them­selves large salary pack­ages with lit­tle re­la­tion­ship to per­for­mance. High-risk mega merg­ers are em­barked upon, which of­ten have lit­tle chance of cre­at­ing share­holder value. Sim­i­larly, firms of­ten en­gage in un­re­lated di­ver­si­fi­ca­tion which has a low chance of suc­cess. This is fre­quently to di­ver­sify the busi­ness, which re­duces risk for the man­age­ment. How­ever, share­hold­ers would much rather have the cash, so they can di­ver­sify their own port­fo­lio as they please with­out man­age­ment do­ing it for them.

agency prob­lem

This di­ver­gence of in­ter­ests is termed agency prob­lem, and much of cor­po­rate gov­er­nance prac­tice and leg­is­la­tion is in­tended to find ways of align­ing in­ter­ests. How­ever, it is ar­guable to what de­gree it is suc­cess­ful. In many ways, the pri­vate eq­uity in­dus­try and ac­tivist share­hold­ers have been suc­cess­ful be­cause of the fail­ures of cor­po­rate gov­er­nance in listed busi­ness, and the dis­re­gard­ing of share­holder in­ter­ests. Pri­vate eq­uity aligns the man­age­ment with share­holder in­ter­ests by giving them be­tween 15% and 30% of the eq­uity. Ac­tivist share­hold­ers ef­fec­tively bully the chair­per­son and CEO into fa­vor­ing share­holder wishes through me­dia cam­paigns, share­holder let­ters, dif­fi­cult EGMs, and at­tempt­ing to rally sup­port from other share­hold­ers to fire them.

plan­ning and in­vest­ment hori­zons

Fam­ily busi­nesses usu­ally have long-term ob­jec­tives to of­fer gain­ful and in­ter­est­ing em­ploy­ment to the fam­ily and their prog­eny. As a con­se­quence, they plan over longer time hori­zons to de­liver strate­gic suc­cess. A Ger­man fam­ily-owned busi­ness, for which I was a board mem­ber, in­vested a sub­stan­tial sum in a new plant with a ten-year pay­back. UK- and US-listed busi­nesses are nor­mally driven by share­hold­ers into much shorter time hori­zons of an­nounce­ments and even pri­vate eq­uity are plan­ning over three to five years be­fore sale.

Fam­ily busi­nesses are care­ful with re­sources as they are keen to main­tain con­trol and avoid high lev­els of lever­age com­mon in pri­vate eq­uity or of­fer­ing new shares, which di­lutes both own­er­ship and their con­trol. This tight own­er­ship of shares means boards can make rapid de­ci­sions, and are not bogged down with cor­po­rate gov­er­nance mat­ters as is com­mon with listed busi­ness. As a con­se­quence, not only do they treat the money as their own but also avoid high lev­els of risk.

Fam­ily busi­nesses are nor­mally run by the own­ers; so, share­hold­ers and man­age­ment are tightly aligned on ob­jec­tives.

sig­nif­i­cant in­vest­ments

R&D in­vest­ment, for ex­am­ple, is of­ten waste­ful and for ev­ery suc­cess­ful project there may be sev­eral, which are not. Now more ma­jor cor­po­rates are out­sourc­ing R&D on con­tracts and buy­ing up smaller firms which have suc­cess­fully in­no­vated. In ef­fect, large com­pa­nies are of­ten poor at in­no­vat­ing and can squan­der large sums of money in this area. Sim­i­larly, cap­i­tal ex­pen­di­ture pro­grams have a high fail­ure rate with around 20% pro­duc­ing no dis­cernible re­turns and around 70% fail­ing to de­liver ex­pected ben­e­fits, over­spend­ing, or be­ing late. Some of this high fail­ure rate can be at­trib­uted to the process for ap­prov­ing cap­i­tal ex­pen­di­ture. The com­pe­ti­tion be­tween projects, for lim­ited in­ter­nal funds, in­cen­tivizes the man­age­ment to pro­pose rather op­ti­mistic cost lev­els, time scales, and scope. The man­age­ment may as­sume the project will go pre­cisely to plan which rarely arises.

M&A is another area in which much re­sources are wasted with a 25 to 30% over­all suc­cess level and around 60% ac­tu­ally de­stroy­ing value. About half are sold off within five years. Re­search sug­gests that smaller bolt-on deals of­ten add value whilst big­ger deals rarely en­hance share­holder value. Big­ger ac­qui­si­tions usu­ally cost dis­pro­por­tion­ately more and are much more com­plex to

in­te­grate. These are all pit­falls, which fam­ily busi­ness is bet­ter at ne­go­ti­at­ing than a listed one. In many ways, a listed busi­ness can gen­er­ate sig­nif­i­cant sums of cash but rather than re­turn it to the share­hold­ers the board en­gages in var­i­ous risky in­vest­ments which of­ten have a low chance of suc­cess, and are likely to de­stroy share­holder value.

pri­vate in­ter­ests and the busi­ness

How­ever, a fam­ily busi­ness is not with­out its prob­lems. Fam­i­lies strug­gle to dis­tin­guish be­tween busi­ness and other ac­tiv­i­ties. So, fam­ily din­ners are of­ten busi­ness dis­cus­sions which ex­clude non-fam­ily mem­bers. As a con­se­quence, non-fam­ily may not be con­sulted and may con­sider them­selves ‘sec­ond class cit­i­zens’. There is fre­quently a lack of trust of se­nior non-fam­ily man­age­ment bor­der­ing on para­noia, and a view that se­nior man­age­ment are try­ing to steal the com­pany. This ex­clu­sion and dis­trust mean that at­tract­ing and re­tain­ing high-qual­ity staff can be dif­fi­cult.

Some­times a fam­ily need for money can drive strat­egy, such as when di­vorce oc­curs, and own­er­ship of the busi­ness then be­comes frag­mented. The busi­ness may have to find cash to settle di­vorce bills. The fi­nan­cial needs of fam­ily mem­bers can drive the dis­tri­bu­tion pol­icy rather than the needs of the busi­ness. Growth op­por­tu­ni­ties can be missed and fail­ure to grow com­pared to ri­vals can re­sult in de­creas­ing rel­a­tive scale and scope economies. Mar­ket power and pres­ence can sim­i­larly be re­stricted through fam­ily pri­vate needs.

suc­ces­sion plan­ning

Suc­ces­sion plan­ning in many busi­nesses is of­ten given lip ser­vice as the chair­per­son and CEO do not like plan­ning them­selves out of a job. In­deed, once a clear suc­ces­sion plan is cre­ated, the ob­vi­ous ques­tion be­comes why not sooner rather than later. Con­trast this with the long-term plan for care­ful de­vel­op­ment of a cho­sen fam­ily suc­ces­sor. It is seen as in all fam­ily mem­bers’ best in­ter­ests to pick the right per­son and to con­trib­ute to their ex­pe­ri­ence so that the fam­ily busi­ness can con­tinue to pros­per. The prob­lem arises when an ap­pro­pri­ate in­ter­ested fam­ily mem­ber can­not be found. In such a sce­nario, the dis­posal of the busi­ness or en­gage­ment with an out­sider has to be con­sid­ered. In­deed, the sta­tis­tics for sur­vival through the gen­er­a­tions with only around 3% making it to the fourth gen­er­a­tion are based on the con­stant is­sue of iden­ti­fy­ing an ap­pro­pri­ate suc­ces­sor from within the fam­ily. The gen­er­a­tional change is crit­i­cal and se­lec­tion of the wrong fam­ily mem­ber may have dire consequences. Dis­posal of the busi­ness usu­ally fol­lows be­ing un­able to iden­tify an ap­pro­pri­ate suc­ces­sor from within the fam­ily.

con­clu­sion

There are clear lessons for all from the suc­cess of fam­ily busi­nesses. Firstly, be care­ful with in­vest­ments and do not fall into the traps of de­stroy­ing value through ex­ten­sive in­vest­ment with­out a high hur­dle level and care­ful sen­si­tiv­ity anal­y­sis. The pri­vate eq­uity ap­proach that sub­se­quent in­vest­ments should cre­ate sim­i­lar re­turns to the orig­i­nal in­vest­ment has much to be com­mended. Care­ful and re­stricted in­vest­ment through pe­ri­ods of eco­nomic growth can be bal­anced by a greater abil­ity to ex­ploit op­por­tu­ni­ties dur­ing re­ces­sions when com­peti­tors have their hands tied through high-legacy bor­row­ing lev­els. Iden­ti­fi­ca­tion and care­ful de­vel­op­ment of a suc­ces­sor to the leader re­sult in a much longer ten­ure, and far less chop­ping and re­vi­sion of strat­egy with chang­ing lead­ers. In turn, this re­sults in much longer-term strat­egy plan­ning and im­ple­men­ta­tion.

The fi­nan­cial needs of fam­ily mem­bers can drive the dis­tri­bu­tion pol­icy rather than the needs of the busi­ness.

Ref­er­ences 01 a com­plex ta­pes­try by John A Davis, The Smart Man­ager, Jul-Aug 2014 02 https://hbr.org/2015/04/lead­er­ship-lessons-from-great-fam­ily-busi­nesses 03 https://hbr.org/2014/04/gen­er­a­tion-to-gen­er­a­tion-how-to-save-the-fam­ily­busi­ness 04 https://hbr.org/2014/04/gen­er­a­tion-to-gen­er­a­tion-how-to-save-the-fam­ily­busi­ness

JOHN COL­LEY IS PRO DEAN AT WAR­WICK BUSI­NESS SCHOOL.

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