by David Turner, Managing Partner
The answer appears to be yes. Many of us probably assume that traditional public companies, with their size, capital, and ability to scale, are best positioned for long-term success. But many public companies are losing their edge. In today’s competitive environment, family held companies are most likely to succeed over the long term. According to a Harvard Business Review article, “family businesses have innate strengths over other forms of ownership.”
That conclusion may come as a surprise. For many, the term “family business” refers to a locally focused, mom-and-pop, small, or mid-size company unlikely to last more than two or three generations. The 90 percent fail rate of third-generation family firms is so well known that multiple countries have sayings to describe it.
- Brazil – Rich father, noble son, poor grandson. Pai rico, filho nobre, neto pobre.
- China – Wealth never survives three generations. Fu bu guo san dai.
- Italy – From the stables to the stars and back to the stables. Dalle stalle alle stele alle stalle.
- USA – Shirtsleeves to shirtsleeves in three generations.
It’s important to put this fail rate in perspective. According to a study of 25,000 companies, publicly traded companies last approximately 15 years on average, or less than one generation. In other words, few companies of any kind endure beyond three or four generations.
Family held companies outperform non-family businesses
Many of the top companies in the world are family owned and controlled and create much of the world’s wealth. They include major corporations such as Cargill, Walmart, Porsche, BMW, and IKEA. The Boston Consulting Group says family held companies account for more than 30 percent of all companies with sales of more than $1 billion.
A Credit Suisse survey reports that the annual return generated by family owned companies has been, on average, 5 percent higher than non-family owned companies over the past 10 years. This finding is true for all regions, sectors, and company sizes.
Advantages of family held companies
Family held companies are inherently values-based, a characteristic that attracts today’s top talent. A Bain & Company study found that “people want to work hard because they believe in their company’s mission and values, not just because they hope for a large salary or a fast promotion.” Family businesses tend to weave their values into the fiber of the organization, which can offer a sense of purpose that attracts and retains the most talented people.
Family businesses have a longer-term strategic outlook focused on creating a legacy for future generations. By contrast, an overwhelming 78 percent of leading public company CFOs said they would willing to make decisions that compromise long-term value to achieve their quarterly earnings targets (Journal of Accounting and Economics).
Family companies are more financially prudent, less likely to raise debt, and more willing to invest for the long term than their non-family held peers. They also benefit from tight decision-making structures that can help make them more responsive to changing markets.
Downsides of family businesses
There are downsides, of course, and things can go wrong over time. A family business can become all-consuming. Some family members may feel trapped, with limited opportunity to pursue outside opportunities. A family only leadership team can lose objectivity and become insular, especially when non-family employees and managers are reluctant to challenge the status quo.
Family owned entities may take succession planning for granted. A TD Waterhouse Business Succession poll found more than three-fourths of family business owners do not have succession plans. Even when they do, poorly executed succession planning can strain family relationships and lead to poor performance.
Family businesses also may face governance issues that arise from failing to address discipline or showing favoritism toward certain family members. In addition, they tend to be reluctant to benchmark evolving governance practices and standards.
Family controlled, professionally run
Family controlled companies that are intentional about levering their advantages while mitigating their downsides can strongly position for long-term success.
At Kincannon & Reed, we hear frequently from lenders, banks, and private equity investors that that they will curtail investment in or lending to family businesses until they professionalize executive staff and boards of directors. It’s important to professionalize management and boards with outside talent and to establish governance practices to ensure independent oversight. A strong, diverse, non-fiduciary advisory board can offer much-needed external mentoring and perspective.
The Economist reported, “The best family companies force their heirs to earn their entrepreneurial spurs, perhaps by conquering new regions or entering new industries.” When this doesn’t occur, successful organizations hire carefully from outside the family to ensure the company has the best chance to succeed and remain at the top of its game.
Companies that thrive
The bottom line is, all ownership and shareholding structures and models have advantages and risks. Whatever a company’s structure, the trick is to lever that structure’s intrinsic advantages and mitigate its risks in a clearheaded way. With good governance, well-executed succession practices, and strong leadership talent from inside and outside the organization, businesses of any structure can thrive for generations to come.