The Attributes of Enduring Family Businesses
What is a family business? Technically, it is one where a single family owns a significant share of a company and can influence key decisions, strategy and the appointment of top leaders. Interestingly, 1/3 of all companies in the S&P Index can be classified as family businesses, and in Europe, the ratio is higher. Among smaller US companies, the ratio is estimated to be well over 1/3.
In “The Five Attributes of Enduring Family Businesses” (McKinsey Quarterly, January 2010) two key points were made about family business endurance and performance:
- Less than 30% of all family businesses survive that way into the third generation. In our experience this often happens because of the exponential growth of shareholders (with often widely-different interests) as the enterprise ages through generational change. In fact, we once worked with a failing firm with over 35 voting stockholders—without a single majority owner or leader.
- US-based family businesses outperform publicly-held companies by nearly 3% annually when measured in terms of 10-year total return to shareholders. Similar results were found for European and other international companies.
McKinsey goes on to explain why some family enterprises endure and exhibit superior performance in terms of several key attributes of success. Let me summarize and comment.
- Control and direction for family member participation. Successful firms clearly establish principles and rules for how current and future family members will participate in the business affairs of the enterprise. This may include such issues as: required experience, rules for family-executive appointment and approval, compensation policy, performance expectations and career alternatives. We call it simply protecting the “golden goose.”
- Maintain and control of company ownership. Clear agreements are established between shareholders regarding the sale or transfer of stock. This is particularly challenging with maturing ownership as varied opinions arise regarding how to use (my) company cash flows: invest or distribute. Using cash and capital to buy out unhappy shareholders has its limits and is generally a poor use of capital—unless both planned (i.e.: required) and long-term in nature. Once a family company starts to liquidate itself to satisfy dissident stockholders it can both lose control of the business and open the door to failure.
- Build strong governance processes. A strong Board of Directors (or advisors) comprised of both family owners and experienced or influential outsiders (historically 40% of Board seats) is most often the answer. These Boards are integral to key strategic and investment decisions. Weak Boards lead to serially-bad or poorly-conceived decisions and can bring a company to a disastrous end—family or public. [See our November 2009 E-Letter regarding Boards of Directors.]
- Take a long-term view of growth, performance and investment to build and protect wealth.The operative terms here in our experience are sustained performance and growth, and the management of risk.
- Sustained performance and growth (in terms of free cash flow) will build the real value of the company which will bring a variety of benefits to share holders in terms of both cash and opportunity; and
- Family owners usually have a significant part of their wealth associated with the business. This often leads to more prudence and risk avoidance (or management) than their corporate counterparts. Consequently, family-business leverage (long-term debt as a % of equity) has historically been 5-15% less that similar public-peer companies’ according to McKinsey’s research. Consequently, family-company cost of capital has often been lower than their public peers.
- Family wealth should be professionally managed for the benefit of all owners. This will allow all owners (whether actively involved with the business or not) to benefit from the success of the company and generally increase family and shareholder harmony. Of course, wealth and portfolio management are never a sure thing as the last two years have brought home with great clarity. But, recognizing the need to manage collective shareholder wealth is an important step to take.
- Active charitable activities and social responsibility are often present in successful family companies. This can provide a mission for the family, and meaningful employment for shareholders not actively employed in the business. So while the business does well, the family also has the opportunity to do good.
Family businesses are unique with complex governance and management needs. While the above attributes are both insightful and often true, we believe that a family company must follow one simple rule to assure its continuing success:
With a solid business in place, you will then have the time, energy and resources to address the complexity of family dynamics and harmony.