Thursday, January 14, 2010

Five attributes of enduring family businesses

The keys to long-term success are professional management and keeping the family committed to and capable of carrying on as the owner.
McKinsey Quarterly
JANUARY 2010 • Christian Caspar, Ana Karina Dias, and Heinz-Peter Elstrodt
Family businesses are an often overlooked form of ownership. Yet they are all around us—from neighborhood mom-and-pop stores and the millions of small and midsize companies that underpin many economies to household names such as BMW, Samsung, and Wal-Mart Stores. One-third of all companies in the S&P 500 index and 40 percent of the 250 largest companies in France and Germany are defined as family businesses, meaning that a family owns a significant share and can influence important decisions, particularly the election of the chairman and CEO.
As family businesses expand from their entrepreneurial beginnings, they face unique performance and governance challenges. … Indeed, less than 30 percent of family businesses survive into the third generation of family ownership. Those that do, however, tend to perform well over time compared with their corporate peers, according to recent McKinsey research. …
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. Five dimensions of activity must work well and in synchrony: harmonious relations within the family and an understanding of how it should be involved with the business, an ownership structure that provides sufficient capital for growth while allowing the family to control key parts of the business, strong governance of the company and a dynamic business portfolio, professional management of the family’s wealth, and charitable foundations to promote family values across generations (Exhibit 1).

  • Exhibit 1: For a family business to be successful, five dimensions of activity must be working well and in synchrony.

    • Family

      Family businesses can go under for many reasons, including family conflicts over money, nepotism leading to poor management, and infighting over the succession of 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. Over decades, they develop oral and written agreements that address issues such as the composition and election of the company’s board, the key board decisions that require a consensus or a qualified majority, the appointment of the CEO, the conditions in which family members can (and can’t) work in the business, and some of the boundaries for corporate and financial strategy. …
      Long-term survivors usually share a meritocratic approach to management. There’s no single rule for all, however—policies depend partly on the size of the family, its values, the education of its members, and the industries in which the business competes. …
      As families grow and ownership fragments, family institutions play an important role in making continued ownership meaningful by nurturing family values and giving new generations a sense of pride in the company’s contribution to society. Family offices … can bring together family members who want to pursue common interests, such as social work, often through large charity organizations linked to the family. … It can also keep the family happy by providing investment, tax, and even concierge services to its members.


      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 shareholders’ agreements that usually last for 15 to 20 years.
      Many of these family businesses are privately held holding companies with reasonably independent subsidiaries that might be publicly owned, though in general the family holding company fully controls the more important ones. … Many family businesses pay relatively low dividends because reinvesting profits is a good way to expand without diluting ownership by issuing new stock or assuming big debts. …
      To keep control, many family businesses restrict the trading of shares. Family shareholders who want to sell must offer their siblings and then their cousins the right of first refusal. In addition, the holding often buys back shares from exiting family members. Payout policies are usually long term to avoid decapitalizing the business.
      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.”

      Governance and the business portfolio

      With clear rules and guidelines as an anchor, family enterprises can get on with their business strategies. Two success factors show up frequently: strong boards and a long-term view coupled with a prudent but dynamic portfolio strategy.
      Strong boards
      Large and durable family businesses tend to have strong governance. … On average, 39 percent of the board members of family businesses are inside directors (including 20 percent who belong to the family), compared with 23 percent in nonfamily companies, according to an analysis of the S&P 500.1
      Of course, it’s important to complement the family’s knowledge with the fresh strategic perspectives of qualified outsiders. Even when a family holds all of the equity in a company, its board will most likely include a significant proportion of outside directors. One family has a rule that half of the seats on the board should be occupied by outside CEOs who run businesses at least three times larger than the family one.
      Procedures for all nominations to the board—insiders as well as outsiders—differ from company to company. …
      Family businesses, like their nonfamily 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 nonfamily executives might fear that family members make important decisions informally and that a glass ceiling limits the career opportunities of outsiders. Still, family businesses often emphasize caring and loyalty, which some talented people may see as values above and beyond what nonfamily corporations offer.
      A long-term portfolio view
      Successful family companies usually seek steady long-term growth and performance to avoid risking the family’s wealth and control of the business. This approach tends to shield them from the temptation—which has recently brought many corporations to their knees—of pursuing maximum short-term performance at the expense of long-term company health. A longer-term planning horizon and more moderate risk taking serve the interests of debt holders too, so family businesses tend to have not only lower levels of financial leverage but also a lower cost of debt than their corporate peers do (Exhibit 2).

    • Exhibit 2: Family businesses tend to have lower levels of financial leverage and a lower cost of debt than their corporate peers do.

      • The longer perspective may make family businesses less successful during booms but increases their chances of staying alive in periods of crisis and of achieving healthy returns over time. In fact, despite the unique challenges facing family-influenced businesses, from 1997 to 2009 a broad index of publicly traded ones in the United States and Western Europe achieved total returns to shareholders two to three percentage points higher than those of the MSCI World, the S&P 500, and the MSCI Europe indexes (Exhibit 3). It is difficult to provide statistical proof that the family influence was the main driver. The results were surprisingly stable across geographies and industries, however, and indicate that family businesses have performed at least in line with the market—a finding corroborated by academic research.2

      • Exhibit 3: Publicly traded family-influenced companies often have higher total returns to shareholders than do leading indexes such as MCSI Europe, MSCI World, and S&P 500.

        • This long-term focus implies relatively conservative portfolio strategies based on competencies built over time, coupled with moderate diversification around the core businesses and, in many cases, a natural preference for organic growth. Family-influenced businesses tend to … [make] smaller but more value-creating deals than their corporate counterparts do … . The average deal of family businesses was 15 percent smaller, but the total value added through it—measured by market capitalization after the announcement—was 10.5 percentage points, compared with 6.3 points for their nonfamily counterparts.3
          Nonetheless, too much prudence can be dangerous. … Excessive risk aversion might, for example, unduly limit investments to maintain and build competitive advantage and to diversify the family’s wealth. Diversification is important not only for overall long-term performance but also for control because it helps make it unnecessary for family members to take money out of the business and diversify their assets themselves.
          That’s why most large, successful family-influenced survivors are multibusiness companies that renew their portfolios over time. … In general, family businesses seek a mix: companies with stable cash flows and others with higher risk and returns. …The idea is to renew the portfolio constantly so that the family holding can preserve a good mix of investments by shifting gradually from mature to growth sectors.

          Wealth management

          Beyond the core holdings, families need strong capabilities for managing their wealth, usually held in liquid assets, semiliquid ones (such as investments in hedge funds or private-equity funds), and stakes in other companies. By diversifying risk and providing a source of cash to the family in conjunction with liquidity events, successful wealth management helps preserve harmony. …
          [Recent events] highlight the importance of a professional organization with strong, consolidated, and rigorous risk management to oversee the wealth family businesses generate. For large fortunes, the best solution is a wealth-management office serving a single family…. A wealth-management office that serves a group of unconnected families is an option when individual ones don’t have the scale to justify the cost of a single-family office. …


          Charity is an important element in keeping families committed to the business, by providing meaningful jobs for family members who don’t work in it and by promoting family values as the generations come and go. Sharing wealth in an act of social responsibility also generates good will toward the business. …
          Money alone does not guarantee a high social impact. In addition to the financial and operational issues facing any charitable activity, families must cope with the critical challenge of nurturing a consensus on the direction of their philanthropic activities from one generation to the next. …
          Almost all companies start out as family businesses, but only those that master the challenges intrinsic to this form of ownership endure and prosper over the generations. The work involved is complex, extensive, and never-ending, but the evidence suggests that it is worth the effort for the family, the business, and society at large.

          About the Authors

          Christian Caspar is a director in McKinsey’s Zurich office; Ana Karina Dias is an associate principal in the São Paulo office, where Heinz-Peter Elstrodt is a director.
          The authors wish to acknowledge the contributions of Andres Maldonado, an alumnus of McKinsey’s São Paulo office.


          1 Ronald C. Anderson and David M. Reeb, “Founding-family ownership and firm performance: Evidence from the S&P 500,” The Journal of Finance, 2003, Volume 58, Number 3, pp. 1301–27.
          2 See Ronald C. Anderson; David M. Reeb, “Founding-family ownership and firm performance: Evidence from the S&P 500,” The Journal of Finance, 2003, Volume 58, Number 3, pp. 1301–27; and also Roberto Barontini and Lorenzo Caprio, “The effect of family control on firm value and performance: Evidence from continental Europe,” EFA 2005 Moscow Meetings paper, 2005.
          3 The sample includes 78 deals for family-owned businesses and 494 deals for businesses not owned by families. The acquirers (both kinds of companies) were constituents of the US S&P 500, the German HDAX, or the French SBF 120 (Société des Bourses Françaises 120 Index) stock indexes. Value added through the deal is defined as the change in market capitalization, adjusted for market movements, from two days prior to two days after the announcement. The analysis includes all deals completed from 2005 to late 2009 with a value of over $500 million in which the acquirers’ ownership went from nothing to 100 percent.