Related Expertise: Family Business , Corporate Strategy, Corporate Finance and Strategy
Family-owned businesses are employers of millions of individuals globally, generators of sizable streams of tax revenue, and financial and social anchors for many communities. The families that own these businesses typically exert considerable influence over their management and operations and, as a result, their performance and survival. The decisions that these families make impact their wealth as well as the futures of the people they employ and often the ecosystems in which they operate.
Without guidelines that govern decision making, families may struggle to agree on leadership choices, succession issues, and other contentious topics that can have a substantial impact on their businesses. It is therefore important that families create an operating model that is tailored to their businesses—a model that helps them manage effectively, treat family members fairly, and preempt conflict.
The role that family businesses play in advancing economic growth is hard to overstate. (See “An Economic Bedrock Through the Ages.”) In many major economies, family-owned businesses account for a significant share of all companies. Our analysis of Indonesia, India, and Germany found that family businesses represent 48% to 74% of all manufacturing companies. (See the exhibit.) They also create millions of jobs through direct employment and millions more indirectly. And they inject significant revenue flows into these economies. In Indonesia, family-run businesses generate more than $100 billion (roughly 10% of GDP). In India, that figure climbs to nearly $670 billion (about 25% of GDP). And in Germany, family businesses contribute a massive $1.8 trillion in revenue (approximately 49% of the country’s GDP).
Because family businesses help support ecosystems—creating jobs for family members and employees, revenue streams for suppliers and governments, and stability for their surrounding communities—the failure of these enterprises can have catastrophic implications on economic growth, especially in emerging markets. Yet, the role that family businesses play in promoting and protecting prosperity is not well understood by many governments and regulators, or even by the families themselves. In fact, in some emerging markets, governments and the broader population often resent family business owners because of their wealth—and because of behaviors that seem to flaunt it.
Family businesses come in many different sizes, from small mom-and-pop entities to major regional companies and even global enterprises. Some families serve as owner-managers, a model that is especially common in emerging markets such as India and Indonesia. Other families function as activist investors: one or more family members sit on the company board and provide an ownership perspective on strategy, capital allocation, and management performance. Still others operate as large but passive shareholders, supported by family offices that manage investments and dividend allocations.
Given the variety of ownership and management structures and the needs of different families, it can be hard for families to determine what type of governance, if any, to adopt. The unique nature of family businesses can also make it hard for those seeking to advise or partner with them. (See “What Potential Partners Need to Know.”)
Most nonfamily-owned businesses start out with a handful of people and a loose operating structure. As these businesses grow and bring on new people and investors, they begin to adopt more-formal management structures that articulate ownership rules, decision-making rights, and codes of conduct. These businesses also establish steering and oversight committees that help them run more efficiently. And the legal structure that they adopt—a corporation, for example, or a partnership—subjects them to statutory requirements, such as a formal business charter, an official code of conduct, a board of directors, and other governance norms.
Family businesses evolve similarly, adopting the same management and governance structures that are statutorily required of them. However, family owners tend to neglect structures and rules that govern the family’s own engagement in the business because these are not legally required. But without agreed-upon operating norms, families have little to guide them when conflicts arise. Resulting disagreements can sour relationships and even prove fatal to the business if no effective resolution is found. For this reason, nearly all families can benefit from establishing an operating model that guides their involvement in the businesses that they own. In some cases, a strong family head can define a set of norms that become the de facto family operating model. In other cases, where multiple family members have decision-making roles, the family may wish to bring in external advisors to help define a model. What’s most important, however, is that family members agree on how to manage the business.
A family should take the following four steps when defining an operating model.
Agree on the Family’s Overarching Goal
To implement effective governance, the family should clarify its overall business priority. As the owner, the family has the right to run the company in the manner it feels is most appropriate, but as the manager, it is accountable for delivering sustainable value and growth. The family must therefore decide if its overarching priority is to build a great business, maximize wealth for the family, or put family first by creating opportunities for this generation and future ones. (See “Different Inheritance and Wealth Models Have Different Requirements and Implications.”)
As with any business, there are tradeoffs. A business-first goal may advance the bottom line, but it may also restrict opportunities for family engagement. Likewise, a family-first mindset allows for deep engagement across the extended family, but it can create an exclusive atmosphere that may prevent the company from attracting outside talent with the skills and expertise needed to compete effectively. The family needs to settle on the business priority that best complements its values and take a unified, explicit stance. This decision will inform the business strategy and operating principles.
Anticipate Potential Hot Spots
The family needs to anticipate typical flash points that may derail the business’s success and jeopardize family harmony. Because it can take a long time to rebuild relationships, family members need to be alert to sensitive topics. Issues that can lead to conflict include leadership choices, wealth sharing among family members, and decisions related to running the business. Disagreements can be intergenerational (between parents and their children, for example), intragenerational (between siblings and cousins, for example), or even between a married couple when both are involved in the business.
In the absence of an agreed-upon operating model that addresses the difficult topics, conflicts can escalate. Family members may delay discussing differences of opinion or refrain from initiating conversations around business or management issues lest they be perceived as sowing seeds of discord. When differences are not aired and issues are not resolved, communication among members or branches of the family can deteriorate rapidly. Factions can form, and disagreements can spill over into day-to-day interactions. Anticipating and addressing points of conflict early on, and treating them with sensitivity, can protect the business as well as the family.
Review the Context in Which the Family and Business Operate
No two families or businesses are alike. Families need to take context into account when designing the appropriate operating model by examining three elements.
Ownership Structure. Family members should get a baseline understanding of the current (and future) ownership structure. For example: Is ownership concentrated among a few family members or many? Are there two or more potential successors? Is current leadership near retirement age? Are family members deeply involved in running or overseeing the business, and do they want to be? Are members of the next generation capable of and interested in running the business? The answers to questions such as these can confirm existing norms and help decide if the family’s engagement structure with the business should change.
Nature of the Underlying Business. Family members must understand the underlying business. Do they own more than one company? Do they own a publicly traded company? Do they own a company that operates in more than one industry? How easy or difficult would it be to split up the company?
Characteristics of the Local Ecosystem. Family members need to assess the maturity of local capital markets, societal expectations, and the regulatory, legal, and tax constraints of the jurisdictions in which they operate. These parameters will affect how the business can grow and develop within its ecosystem.
Create Structure for the Family
After agreeing on the overarching goal, anticipating potential hot spots, and reviewing the context, the family should decide on a governing structure. The degree of formality can vary. Generally speaking, the structure consists of a shareholders’ agreement, a description of governing bodies, and a family code of conduct.
Shareholders’ Agreement. Although small family businesses and those operated for only one or two generations may not need an explicit shareholders’ agreement, all families should, at a minimum, gain consensus on three points:
Governing Bodies. Formal governance structures become more important as the number of family members involved in the business grows. Small families or those that have a relatively new business can make decisions informally, as long as family members are in agreement. Larger families often benefit from establishing two governing bodies to manage the family’s interests: a family assembly and a family council. These are in addition to committees that help run the business.
The family assembly is often quite large, comprising all family members who have an ownership stake in the business and sometimes even those who do not, such as children and spouses. The family assembly is responsible for key activities, including selecting members to the family council, assigning decision rights, and establishing broad parameters under which the council operates.
The family council is smaller than the family assembly. Because the council’s primary function is oversight of the family’s business affairs, it is also vested with decision-making authority regarding those matters. The family council functions like a board of directors, and the chairperson is usually a senior family member. The council has responsibility for making major decisions that impact the family and the business, such as selecting the CEOs for portfolio companies from within the family or deciding the amount of annual dividend payouts. Council members are elected through a vote in the family assembly and serve for fixed terms. Given the power held by the family council, we recommend the following best practices:
Family Code of Conduct. A code of conduct is essential for all family businesses, regardless of their size. It is arguably the most important document in keeping the peace among family members, since most conflicts tend to arise over the nature and manner of interpersonal interactions, rather than a specific business topic.
In essence, the code of conduct is a set of rules that describes how members of the family are expected to behave when they interact and talk with one another—and with the public. The code must emphasize how family members should air any issues and the mediation process to resolve them. It may also lay out expectations concerning lifestyle and behavioral choices that family members can lead, especially with respect to overt displays of wealth. (See “Families Need to Be Sensitive to Income Inequality.”) Penalties for violations of the code must also be detailed. A thoughtful code of conduct can be the difference between a swift, private, and amicable resolution and a protracted and public legal battle.
Family businesses are an important driver of economic growth, especially in emerging markets, where the ability of these businesses to take on risk has resulted in jobs for family members and employees, revenue for governments, and stability for communities. However, managing family businesses is complex, given the close personal and professional relationships involved. Establishing governance rules and setting expectations can help protect the growth of family businesses and their ecosystems for generations to come.
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