Family Business Chapter 1

4 Distinct parts of a family business

1. Ownership control is 15% or higher by two or more members or partnership of families 2. Strategic influence by family members on management 3. Concern for family relationships 4. The dream of continuity across generations

4 Characteristics of family firms

1. Presence of the familiy 2. Overlap of family, management, and ownership 3. The unique sources competitive advantage derived from family interaction, management, and ownership, especially when family unity is high 4. The owner's dream of keeping the business in the family

Extra Cost factor to the agency theory

1. The CEO's ability to hold out, based on his or her status within the family 2. a preference for a less business risk 3. lack of career opportunities of non family agents 4. lack of monitoring of family members' performance 5. lack of monitoring of the firm's performance 6. avoidance of strategic planning because of its potential for fostering family conflict 7. Conflict between manager-owners and nonfamily managers A set of managerial practices as opposed t one specific practiced will facilitate control of these unique agency costs

The Agency Theory Perspective

Argued that the natural alignment of owners and managers(Agents) in a family business decreases the need for formal supervision of the agents and fore elaborate governance mechanisms, reducing agency costs of owner in family firms. THe opposite is proven true.

The Alternative to Blurred system boundaries: Joint Optimization

Capacity to jointly optimize interrelated subsystems in such a way that the larger system can be most effective and successful in the pursuit of its goals. To facilitate that joint optimization of family management and ownership, there are policies written that guide employment of family and involvement of members in nonmanagement roles. Some become shareholders, others remain employees. Reviews are done by the same as others.

The Strategic Perspective: competitive challenges faced by family businesses

Family business owners are also well aware of the increasing individualism in younger generations, whose members often view extended family and legacy as if they were alien constructs. On the other hand, next-generation members are often concerned about what they perceive as the entrenchment of the current-generation CEO. In an era in which life expectancy has increased significantly, fears about the CEO never relinquishing power may be difficult to dispel.

WHAT CONSTITUTES A FAMILY BUSINESS?

Family businesses come in many forms: sole proprietorships, partnerships, limited liability companies, S corporations, C corporations, holding companies, and even publicly traded, albeit family-controlled, companies.

FAMILY-FIRST BUSINESSES

In family-first family businesses, employment in the business is a birthright. The stereotype of nepotism, which still dominates most people's views of family businesses, derives from this not-so-infrequent suboptimization of the family business system. The absence of balance and clear boundaries between family, ownership, and management is not always resolved by putting the family first. On the contrary, business management or ownership could just as easily be favored in decision making and action taking, again to the detriment of the whole family business system.

OWNERSHIP-FIRST BUSINESSES

In ownership-first family businesses, investment time horizons and perceived risk are the most significant issues. When shareholders come first, the priority is risk-adjusted economic returns or owner rents—for instance, shareholder value, EBITDA, earnings growth rates, and debt/equity and debt/asset ratios. These family members can cause the business to lose the founding culture, which valued the role of patient capital, or investing in the family business for the long term.

The Systems theory perspective

In the systems theory approach, the family firm is modeled as comprising the three overlapping, interacting, and interdependent subsystems of family, management, and ownership. According to the systems theory model graphically represented in Figure 1.1, each subsystem maintains boundaries that separate it from the other subsystems and the general external environment within which the family firm operates.

MANAGEMENT-FIRST BUSINESSES

Management-first family businesses are likely to actively discourage family members from working in the business and/or to require work experience outside the business as a prerequisite for employment. As an asset, it could just as easily be folded into a larger company through a tax-free exchange of stock with a publicly traded corporation or sold through an employee stock ownership plan.

Family Business in US Contd

On the down side, approximately 85 percent of all new businesses fail within their first five years of operation.

Difference between family business and management style business

Ownership structure aside, what differentiates family businesses from management-controlled businesses are often the intentions, values, and strategy-influencing interactions of owners who are members of the same family. The result is a unique blending of family, management, and ownership subsystems to form an idiosyncratic family business system. This family-management-ownership interaction can produce significant adaptive capacity and competitive advantage. Or it can be the source of significant vulnerability in the face of generational or competitive change.1

3 Characteristics of the family form of governance

Parsimony Personalism Particularism

BLURRED SYSTEM BOUNDARIES

Research in the social sciences—both psychology and economics, for example—suggests that emotion can lead to behaviors and actions that rational thought would seldom support. Lack of awareness on the part of company employees or family members that the particular assumptions that go into decision making are based on whether an issue is considered a family, ownership, or management issue may create incongruent policies and bad decisions

Family Business

Taking into account this full range of research and analyses, this third edition of Family Business considers family businesses to constitute the whole gamut of enterprises in which an entrepreneur or next generation CEO and one or more family members significantly influence the firm. They influence it via their managerial or board participation, their ownership control, the strategic preferences of shareholders, and the culture and values family shareholders impart to the enterprise.

Family Business in US

The evidence therefore says that U.S. firms with founding-family ownership perform better, on average, than nonfamily-owned firms. This strongly suggests that the benefits of family influence often outweigh its costs.

Competitive Advantage: The Resource-based view

The unique resources that family businesses can call on to create competitive advantage are: 1. Overlapping responsibilities of owners and managers, along with smaller company size, which enable rapid speed to market. 2. Concentrated ownership structure, which leads to higher overall corporate productivity and longer-term commitment to investments in people and innovation. 3. A focus on customers and market niches, which results in higher returns on investment. 4. The desire to protect the family name and reputation, which often translates into high product/service quality and the higher returns on investment that being a high-quality leader produces. 5. The nature of the family-ownership-management interaction, family unity, and ownership commitment, which support patient capital, lower administrative costs, skills/knowledge transfer across generations, and agility in rapidly changing markets. They can also make quick decisions

3 Patterns of succession in Family Business

Wavering: The next generation is paralyzed by indecisiveness, unable to adapt the business to current competitive conditions; it also fails to make its mark and assume leadership effectively. Conservative: The parent has exited the business, but the parental shadow remains, and the business is stuck in the past. Rebellious: It is often the overreaction to the previous generation's control of the firm and the new generation prefers a clean slate.

The Stewardship perspective

claims that founding-family members view the firm as an extension of themselves and therefore view the continuing health of the enterprise as connected with their own personal well-being. stewards of the firm, family owners often place individuals on the board who have industry knowledge and who can provide objective advice and advocate for a going concern. The independence of the board is less an end in itself than a reflection of the family's commitment to avail itself of complementary skills that the family lacks, such as legal, financial, succession-planning, accounting, and international-marketing skills and knowledge.

Parsimony

refers to the propensity of family firms to be vigilant about their financial resources, due to the fact that the family owns those resources.

Strategic preferences

refers to the risk preferences and strategic direction family members set for the enterprise through their participation in top management, consulting, the board of directors, shareholder meetings, or even family councils.

Personalism

refers to the unique power resulting from the combination of ownership and control held by the same family. This concentration of power frees family firms, relative to nonfamily firms, from the need to account for their actions to other constituencies, giving them the discretion to act as they see fit.

Culture

the collection of values, defined by behaviors, that become embedded in an enterprise as a result of the leadership provided by family members, past and present. Family unity and the nature of the relationship between the family and the business also define this culture.

Participation

the nature of the involvement of family members in the enterprise—as part of the management team, as board members, as shareholders, or as supportive members of the family foundation.

Particularism

the product of this concentration of power and its resulting discretion. Family businesses, scholars argue, have the particular ability to use idiosyncratic criteria and set goals that deviate from the typical profit-maximization concerns of nonfamily firms. And these three characteristics provide family firms with advantages in efficiency, social capital, and opportunistic investment

Ownership control

the rights and responsibilities family members derive from significant ownership of voting shares and the governance of the agency relationship.