Business longevity in family concerns

A study of family businesses shows that 30% survive to the second generation, 13% to the third generation and 3% survive beyond that (Zellweger 2017). Those that survived to several generations had incoming generations that brought value to the business, typically a form of education from which skills and knowledge could be applied to the business. There was also a transition in management from one generation to another as the successor was eased into the business and given time to start their own projects. Spouses were incorporated into the business family and encouraged to belong to it, helping the successor through this process. Longstanding business families are careful not to automatically have siblings equally sharing inheritance of family business shares. The sibling that does inherit the largest equity stake is instead put in a position to support their siblings; this provides focused leadership and ownership but with a caretaker approach in the holding of power and resources by the successor. In short, strategic planning of the succession is critical for successful transition as the odds are against the family business surviving as the generations pass.

These figures might seem depressing but bear in mind that perhaps half of new start-ups exist 5 years later. Sometimes trying to turn around a failing business is not worth the effort in a sector of great overcapacity or undergoing technological change. This closure is part of creative destruction as new businesses emerge based on new models, new markets and new technology.

Sometimes family members may not stay with the family business, but the family tradition continues in the sector as the member starts a new enterprise. This can be seen across sectors from farming to high finance. A family exit might be best for the business considering the context of the family and the business. Such a trade sale, private equity sale or listing might be lucrative for the family, supporting their finances for several generations. Indeed, it might support the new venture(s) mentioned above, taking the family from being a family business to a business family with multiple business interests.

Being a business family requires a change of mindset from being a family in a family business. The emphasis is not on business longevity, succession and value preservation. It has another agenda. Change and entrepreneurship become more important. This could be expressed in new ventures or new offerings from existing businesses. As the business interests of the business family could change more frequently than in a family business, then each generation in a business family requires this change and entrepreneurship awareness. Harnessing this requires freedom for individual family members to be creative with new ideas. This will create support for innovation for new services and products. It also allows the individuals to be proactive to follow up new opportunities. Implicit in this is risk taking; some projects will fail, but that is the cost of finding successful and profitable projects. The failure of a particular venture will not be the business failure of the business family as a whole as the rest of its portfolio will remain intact.

The search for opportunity from change and entrepreneurship may involve a portfolio of business interests with a focal sector in the portfolio, perhaps reflecting the nature of the original family business and thus the historic expertise of the family in its original sector. Yet within that portfolio will be a degree of diversification. Often this is related diversification so existing family knowledge, skills and connections can be brought to bear on the new market in successful combination. The diversification provides some counterweight to the risk of any particular venture.

The more diversification, the less the family’s skills, knowledge and connections are relevant, and more reliance will be on non-family management and advice. The portfolio approach brings the possibility of investment by others in the portfolio if the family wishes. This will give size to the portfolio. This can be done in a number of ways, but one that is notable from reading the business pages of a newspaper are the listed investment trusts that have a core holding by a wealthy family sitting alongside funds invested by the general public and financial institutions. The resulting portfolio size and spread is larger than the family would have attained on its own.

This is when business management becomes investment management. In this scenario, it is important to be aware that non-family management and external advisers have less incentive for the efficient allocation of capital, perhaps because just doing a deal and getting a fee is more important than long term strategy. It is a form of the agency problem found in finance theory. Therefore, there remains the need for family strategic involvement for the optimum management of the portfolio. In part this explains the continued Wallenberg family involvement in its Swedish investment house, Investor AB, over many decades.

Not all families in family business move to the business family model or further to setting up investment trusts. Instead they may hold several family businesses, but sequentially: one after the other. Sale of the earlier business provides the resources to invest in the new venture. The family also provide their prior business experience and their connections for the new venture. The change from an old venture to a new one may be due to the degree of maturity and complexity of the old venture or the state of the market (push factors) or the attraction of change or entrepreneurship in other sectors (pull factors).

The portfolio and sequential family business route run more smoothly with a family holding company as an apex incorporated entity sitting above and owning whatever business activity is going on. It allows for capital allocation and a dividend policy reflecting all the family’s business activity. The portfolio and sequential family business approaches to business emphasize the value each generation adds in a way that ‘family in business’ (business family) is a better description than the traditional phrase – family business. Many entrepreneurs and family managers are wrapped up in immediate business management, but consideration of the issues set out in this article place their businesses and families in a stronger position for family succession and wealth creation in the long term. My colleagues and I at nexa law look forward to discussing how we may assist families with the continuation of their business interests through business succession, portfolio structuring and setting up investments.

For more information please contact Henry Clarke using henry.clarke@nexa.law