Family Business (Management 321) Ch.1-7 (midterm)
What Makes Family Business Different from a Traditional Business?
- 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 the interaction of family, management, and ownership
The Family Systems Perspective (cont.)
-Argues that while families often look to an individual to blame whenever there is trouble and tensions mount, sharing responsibility for the difficulty and its remediation is more effective than individual solutions -Argues compellingly for the tremendous influence of an individual's family of origin •Patterns and processes set in motion from two or three preceding generations still matter •The analysis of earlier generations is essential to understanding what ails or distresses a family in the present
Benefits of Board to FB:
-Board holds CEO and top managers accountable rather than family members having to hold one of their own accountable -Outsiders provide unbiased objective viewsBoard members bring fresher, broader perspective to business issues -Board members bring with them network of contacts -Boards can help mediate the predictable conflicts between a parent and a next generation, between siblings, and between an owner-manager and other shareholders
Unhealthy Family Culture
-Characterized by: •Secrecy •Lack of information •Low levels of family emotional intelligence •Little knowledge of the business among at least some family members -A result of: •A founding culture that supported autocratic leadership •The family's belief in benefits of privacy •Zero-sum dynamics: win-lose between members or branches
•Three patterns of ineffective succession were identified in one study:
-Conservative (not willing to change) -Rebellious -Wavering
Relative Product Qualityand Business Performance
-High relative quality: 27.1% ROI -Medium relative quality: 19.8% ROI -Low relative quality: 16.8% ROI
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
•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
Two watershed events played key roles in turning the study of family business into a field:
-The publication of a special issue of the journal Organizational Dynamics in 1979 -The launching of a specialized journal, Family Business Review, in 1986
Size of Market and Business Performance:
-Under $50 million : 28.1% ROI -$50 to $100 million : 26.8% ROI -$100 to $250 million : 24.2% ROI -Over $1 billion : 10.9% ROI
When does an entrepreneurial company typically become "a family business?"
...Typically when the next generation - "the kids" join the business within ten years of having graduated from college.
Responsibilities of Shareholders to the Company:
1.Define and then demand what are reasonable returns on shareholder equity or invested assets 2.Provide the values and principles of doing business and ensure they remain instilled in the company 3.Define the owning family's strategy and communicate owning family priorities
Benefits of Shareholder Meetings:
1.Educate owners about responsibilities and shareholder expectations 2.Provides opportunities to share financial, business and competitive info sharing 3.Best safeguard for healthy governance on the business and vice versa
Ownership Structure and Classes of Stock:
1.Ownership structures frequently do not transfer well across generations especially when next generation ownerships don't work in the business. 2.One approach to this challenge is to redesign the capital or ownership structure of the company by recapitalizing its stock (e.g., recapitalizing the common stock into two classes: voting and nonvoting) 3.Phantom stock can also be created in order to provide the incentives for key nonfamily management to behave like owners 1.Phantom stock mirrors the value of regular company stock but does not dilute the family's actual ownership and has no voting rights
Family Business Theories
1.Systems theory 2.Agency theory 3.Resource-based theory 4.Stewardship theory
Investments in the Ownership Subsystem: -That means investing in:
1.The design and execution of an appropriate ownership and control structure 2.The education, access to information, and engagement of shareholders 3.The creation of institutions that govern the ownership-firm interaction
Family-controlled firms in the S&P 500 achieved...
53% greater economic value added than their management-controlled counterparts
•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
Management mission:
Competitiveness,Growth, CareerOpportunity,Profit
Ownership mission:
Return on InvestedCapital, Family Unity,Shareholder Value, Continuity
•Average tenure of the CEO is 18 years versus 18 months to 3 years for the average CEO of an...
S&P 500 company
Ownership Structure: Leading •Leaders of enterprises find that distributing voting shares equally among shareholders often erodes a next-generation owner-manager's ability to lead-Why?
Unlike ownership, the authority to lead should be earned rather than inherited
The most prevalent reason why family-owned and family-controlled companies fail relates to...
a failure in succession planning
•Average share holding time is...
a generation vs. 9 months in Fortune 500 companies
High scores on family unity combined with high scores in career opportunities in the business produced...
a high score indicating a positive family-business interaction
•Family unity is a strong predictor of the successful use of...
a set of best managerial and family practices by family companies
The Role of the Board: •The family's identity remains attached to the company's, so if the company is going to change in order to...
adapt and grow, sometimes the board composition has to change
EDI/Internet-based partnerships in the supply chain make...
agility possible across value chain
Between 1975 and the early 1990s, most of the published work on family businesses was...
anecdotal, rooted in the stories of consultants and observers of these mostly privately held enterprises
•The us-and-them dynamic can be triggered by...
any perceived difference: male-female, active in management-inactive in the firm, older-younger, richer-poorer, etc.
The Role of the Board: -Research has found that higher-performing firms are those in which independent directors...
balance family board representation
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.
The Role of the Board: -The superior performance in shareholder value is...
contingent on the composition of the board
•Family businesses aspire to...
continue across generations of owners or owner-managers
•The focus of family councils should be...
conversations, deliberations, and policy making
The Role of the Board: •Because of the board's importance, next-generation leaders of family companies frequently undertake a...
critical review and restructuring effort involving their board
The Role of the Board: •Great deal of communication and education needs to take place beyond what is...
deemed traditional board work and strategic planning processes, because of the family's legacy on the board
•Zero-sum dynamics are characterized by...
exchanges in which one party's perceived gain is the other party's perceived loss
•24 percent of family businesses surveyed have a...
female CEO or President. This far outstrips the 2.5 percent of Fortune 1,000 firms which are led by women.
•The absence of growth (and increased wealth and career opportunities) in the family business is...
fertile ground for zero-sum dynamics
Information, Communication, and Education of Shareholders: •Shareholders who are not sufficiently informed and involved can...
get suspicious and concerned
Without this knowledge, family-business shareholders can become indifferent and impatient, and can...
hamper effective operation and growth
Family shareholders expecting to fulfill their responsibility of aligning management interests with shareholder priorities and holding management accountable need to...
have a thorough understanding of financial statements
The company continually optimizes the mix among family, management, employees, customers, and ownership for...
higher long-term profitability
Concentrated Ownership results in...
higher overall corporate productivity
Family Councils:
is governance body focusing on family affairs and serves family as board of directors serves business
Investments in the Ownership Subsystem: •If a family business is going to preserve one of its intangible yet well-documented competitive advantages—its propensity to...
manage with a long-term horizon—investments in the ownership subsystem is essential
Family firms created an additional 10% in...
market value during the 1992-1999 period
Information, Communication, and Education of Shareholders: •Information regarding the estate plan also...
needs to be shared with family shareholders
Family meetings can provide a forum for minimizing the potential for conflict and addressing the troublesome problems that confront multigenerational families. Unfortunately, family conflicts frequently are...
not addressed.
The Role of the Board: -Research has also found, though, that a moderate family board presence provides substantial benefits to the firm, so the addition of independents and advisors is...
not meant to exclude continuing family participation on the board
The overlap between owner and manager or principal and agent 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
Information, Communication, and Education of Shareholders: •As part of their financial literacy, owners should also be able to understand the capital structure of the firm, know debt levels in relation to owners' equity, and therefore be able to gauge their ability to...
operate independently or risk influence by banks and other sources of capital in how they run their business
Emotional competence inventories with their 360-degree feedback process can be...
particularly helpful to next-generation members of a family in business
Boards and performance: •The biggest contributor to family firm outperformance is the presence of the founding CEO - the entrepreneurial effect •Board composition in family-controlled firms in the S&P 500 found that companies in which independent directors balanced the influence of founding families on the board,...
performed better and created greater shareholder value.
Information, Communication, and Education of Shareholders: •The particularly appropriate measures of...
profitability for a company in a particular industry, plus measures of return on invested assets, return on shareholders' equity, return on sales and the growth trajectory of the above over time are essential to have and understand
Family-controlled firms had a 6.65% greater...
return on assets (in EBITDA terms)
Customization, changing consumer preferences, and shorter product life cycles...
reward agility
•Family councils foster open and safe processes for...
sharing information
•Firms in which founding family ownership remained (and relatively few independent directors served on the board) performed... [The findings of this research follow earlier findings that seemed to point to effective governance requiring active, caring oversight in addition to independence.]
significantly worse than nonfamily firms.
The greater flexibility of new manufacturing and distribution-retail-service technology makes...
smaller runs economically attractive
Family foundations represent 55.5% of...
the 200 largest foundations in the US and 56% of the annual giving ($1billion).
Ultimately, emotional intelligence seeks to increase...
the ability to handle feelings with skill and harmony even in the face of differences between family members, so that better decisions can be made and teamwork and family unity can thrive
Concentrated Ownership: The higher performance seemed to be related to...
the different posture taken by these firms toward diversification and investment in training and development, and research and development
Only in the past decade has research begun to struggle with this definition of...
the family business and address the uniqueness of this form of enterprise
Educating and Informing Shareholders: they need to be able to make sense of what the numbers say about...
the firm and its competitive condition
Average tenure of 18 years for owner-managers vs. 8 years for public company CEOs is correlated with commitment to...
the long term and making efficient long-term investments in the family business
This positive family-business interaction factor was a great predictor of...
the number of best management/ governance practices implemented and the source of a hypothesized virtuous cycle
The Role of the Board: -The role of the board is prominent in the governance of the relationship between a family and its business when...
the owner-family-business interaction is perceived as a positive-sum dynamic
Governance: •Family firms need help in governing the family-owner-management relationship •The desired outcome is rational economic and family welfare decisions unencumbered by...
traditional family dynamics
There are between 17 and 22 million family-owned businesses in the U.S. true or false?
true
•Annual revenues exceed $25 million for 35,000 family businesses. true or false?
true
Building Family Businesses That Last
•Building a family business so that it continues takes ongoing dialogue 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 on the one hand and promoting growth and adaptation to changing competitive dynamics on the other
The Family Systems Perspective
•Considers the family to be the building block of emotional life •Uses systems thinking to understand the complex interaction between individual members of the family •Suggests that change in any family member's behavior is more likely to be sustainable at the family than at the individual level •Argues that the interdependence that is the source of social/physical/intellectual/emotional rewards in the family also gives rise to conflicting needs, desires, and priorities as the family grows and ages
Family Businesses...
•Constitute 80-98% of all businesses in the world's free economies•Generate 49% of the GDP in the U.S. and more than 75% in most other countries •Employ 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.
Buy-Sell Agreements:
•Contractual agreements between shareholders and the company •Typically used by family-business owners to facilitate an orderly exchange of stock in the corporation for cash •Often the primary vehicle through which family shareholders can realize value from their highly illiquid and unmarketable wealth—company stock •The most obvious benefit of a buy-sell agreement is that it allows some family members to remain patient shareholders while providing liquidity to family members with other interests or goals
Family Businesses Can HaveLower Overall Costs
•Cost of capital is nearly 0% 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
•The council may suggest policies such as:
•Employment and subcontractor policies •Board service and family council service policies •Dividend and liquidity policies •A family constitution
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 may be obtuse by design, 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
Joint Optimization Alternative
•Family employment policy guides the employment of family members •Some family members are employees; others are responsible shareholders •The performance of employed family members reviewed in the same manner as that of nonfamily managers
•Governance can be provided for through ownership structure, different classes of voting and nonvoting stock, buy-sell agreements, a family constitution •Can be enhanced by contributions from:
•Family meetings/councils/assemblies •Boards of directors/advisory boards •Family offices •Top management teams
Joint Optimization Alternative
•Family members are encouraged to work outside the business to get experience •When family members meet, conversation is both family and business oriented •Families and firms have a commitment to family business continuity
A board's role in succession planning:
•For a parent, the anguish of having to pick one, and just one, of his/her children to lead the family company is hard to imagine. •Board members may have to rely on many others for the facts. But independent outsiders are in an ideal position to review the facts and render objective opinions and recommendations. A board is in the unique position of being able to enhance the perceived quality and fairness of the decision. •A board of directors can question the implicit assumption that only continuity with family members as owner- managers, is desirable. Continuity in founding family hands is not the only indication of success. A wealth-producing exit (IPO, PE or sale) may be best.
•Family meetings can address existing problems such as:
•Frustration over alienation or lack of inclusion •Anger over the unfairness of hiring practices, promotions, family benefits, etc. •Frustration over dividends and lack of liquidity
Guidelines for Policy Making
•Ideally, involve as many family members as are relevant to the particular policy being developed •Look at the big picture, and formulate a mission statement or outcome goal that defines what is best for the extended family and the business •Focus on the future and let go of the past •Use experienced facilitators, who can play a significant role in helping a family business focus on the future, and benchmark your drafts of policies against those of other successful family-owned or family-controlled companies •Agree on the process you will follow to develop, review, edit, redraft, approve, and ultimately enact policies with the confidence that people will support them because, after all, they helped create them
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
•Family unity is also a defining element in the relationship between the owning family and the business. It affects...
•It affects the firm's ability to capitalize on the unique capabilities and/or resources that family members bring to the company's business model •It helps the company translate core competencies into a unique set of competitive advantages
Challenges of Wealth:
•Loss of family identity and values •Family conflicts •Current leader's inability to let-go•Affluenza •Dilution of wealth•Lack of transparency •Lack of oversight •Keeping it in the family
Core Competencies/Attributes Turned into Competitive Advantage
•Overlapping responsibilities of owners and managers, along with small company size, enable rapid speed to market •Concentrated ownership structure leads to higher overall corporate productivity and longer-term commitment to investments in people and innovation •A focus on customers and market niches results in higher returns on investments •The desire to protect the family name and reputation often translates into high product/service quality and higher returns on investment •The nature of the family-ownership-management interaction, family unity, and ownership commitment support patient capital, lower administrative costs, skills/knowledge transfer across generations, and agility in rapidly changing markets
Concentrated Ownership
•Ownership structure impacts corporate productivity •Stock concentration is positively correlated with: -Related diversification -R&D expenses per employee -Training expenses per employee -Overall corporate productivity
The degree of family unity, how the family perceives business opportunities, and how positive the relation is between firm and family all influence the managerial practices used and the extent of their use
•Planning activity •Performance feedback •Succession planning disclosure •Advisory boards •Family meetings
The Benefits of Family Meetings
•Provide a reliable forum for delivering information about the state of the business, its financial performance, its strategy, and the competitive dynamics it faces •Offers a safe haven in which to teach family members about the various rights and responsibilities that accompany being a business owner and manager
Family Emotional Intelligence
•Refers to the capacity to recognize our own feelings and those of others and the ability to manage our emotions and relationships with others
Resource-Based Theory
•Resource-based theory highlights unique capabilities or resources that family firms convert into competitive advantage •These resources are often referred to as organizational competencies •The ability of a particular family business to capitalize on its unique advantages depends on the quality of the interaction between business and family
The Strategic Perspective: Competitive Challenges Faced by Family Businesses
•Shrinking product life cycles•Intense cost competition •Rapid change in distribution and value chains •Increasing individualism of younger generations •The entrenchment of the current-generation CEO
Makeup of FB Board:
•Small group—five to nine members •Majority should be independent outsiders •Should not be friends of the family •Should not be business's service providers •No managers other than CEO •Successors only when succession imminent •At-large family representation
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
Stewardship Theory
•This 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 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
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 •Agency costs can be controlled or avoided through the use of certain managerial and governance practices •The board of directors is important in monitoring managerial behavior and controlling costs