During the 2008 crisis, we rediscovered the virtues of family businesses. They offer a lot of advantages over listed companies: stable shareholding, long-term management, prudence and low levels of debt. So much so, that they were referred to as « the last bastions in the crisis » in a study by the UBS bank.
WHAT IS A FAMILY SME?
They are generally categorised as companies with a turnover of less than £25million, although there are some very famous large family businesses such as Hermès which are owned by the founder and family, or their descendants. A family SME is run by a member of the family, with relatives, children, cousins and/or spouses usually taking management positions.
A LONG-TERM VISION
Whereas listed companies are subject to stock market regulations and management has to focus on short term six-monthly or even quarterly results, family SMEs share a heritage vision. When Owner/Managers seek long-term increases in value, they are more interested in being able to pass on a healthy business to their children, than making a killing.
This concern for a sustainable business gives them 4 major advantages:
- Stability: Studies have shown that family SMEs are half as likely to file for bankruptcy as other types of businesses. There are other reasons for this as well as the obvious financial ones. When family wealth is wholly invested in a business, there are not many family Owners who will take a punt on a dodgy development that would put at risk the entire family’s security and employment.
- Resilience: Similarly, both in times of lasting economic crisis or temporary difficulties, we know that family businesses fare better than others. Family shareholders understand management imperatives better, and can reduce or temporarily eliminate dividends to strengthen their business by making trade-offs between their short-term and long-term interests.
- Prudence: Family capitalism is less greedy than stock market capitalism. A significant part of the profits made are set aside, to strengthen the balance sheet and the cashflow.
- Debt caution: Growth is often achieved by being self-financing and paying low dividends. Owners refuse risky or high-rate finance arrangements, regardless of the term. They are accustomed to doing more with less, which means they can be frugal and agile.
MORE EFFECTIVE MANAGEMENT
Decision-making is easier and quicker in a family business than in an externally financed company because there is better dialogue between managers and shareholders!
Managers tends to be closer to the employees and the resulting dialogue tends to be on a more human level and less likely to degenerate into power struggles. Any difficulties can be smoothed out and work disagreements can be avoided.
There is often greater employee loyalty and dedication. The personality of the founder, their personal history, aligned with that of the company which usually bears their name, makes it easier for all staff to get behind any important growth project.
We know of a very good engineering company in which the majority shareholder, the grandson of the founder, had handed the responsibility for overseeing a major diversification process to one of his executives. This new Managing Director took a guns-blazing approach to change in size, which generated so many internal clashes that the heir had to take back control. Helped by the legitimacy of his business name, he was able to give guarantees to the staff about preserving the core identity of the company – which then doubled its turnover in three years. Paradoxically, the employees had been more concerned than he was about respecting the company history during the diversification. They identified strongly with the business, because their fathers before them had worked there too.
The RISK OF paralysis!
The flip side is that over the longer term, the many positives we’ve just highlighted can become just as many negatives:
- Debt caution can also become an obstinate refusal to borrow: « my father developed his business without borrowing a penny, I can do the same ». This fails to see that the world has changed, that rates are low and that opportunities can be missed by being too careful.
- Stability that preserves the family wealth can turn into fear of taking risks. The Owner/Manager sees what they have to lose rather than what the family could gain, the risk/benefit balance that every entrepreneur has to manage always tilts the same way, and turnover stagnates.
- Family links between shareholders and Owner/Managers, which favour action when all is going well, can lead to total paralysis when parents and children don’t agree on the strategy to be pursued, or when problems external to the business start to pollute family relationships. How many flourishing companies have we seen die because of family disagreements rendering them incapable of making a decision?
HOW TO mitigate THESE RISKS?
Some suggested ways to avoid paralysis based on our experience:
- Prepare for succession; don’t wait until the last minute.The eldest child is not necessarily the most competent or the one most motivated to ensure family business continuity …
- Be clear about who actually runs the company. Including family members on the Board of Directors doesn’t mean that the Owner/Manager abdicates responsibility for making decisions.
- Always ensure that there is a majority holding. Be careful about distributing blocks of votes equally between brothers and sisters: it may render a company ungovernable.
- Have the courage to look outside the family, for a professional and dispassionate vision. A (truly) independent administrator for the Board of Directors, or an experienced consultant is ideal.
1 UBS January 2009