By Exchange Magazine
The nitty-gritty of running a fluid family business

Different models for different times can lead to lasting success - by Paul Knowles

The description “family business” may seem simple enough – obviously it means “a business owned and operated by members of a family.” Or is it that obvious? Might the business be owned by a family, but operated by other employees? Might only some members of the family own the business? Might only some work there? Might there be partners who are not family members?

Not as simple as it seems. And because not all family businesses are created equal, the ownership, operational and governance models must also be diverse, to meet the needs of this surprisingly diverse category of companies.

An article in the Harvard Business Review, written by American family business advisors Josh Baron and Rob Lachenauer, suggests that there are “five basic ownership models: owner/operator, partnership, distributed, nested, and public.”

“Non-family executives must know how to play politics ... between the business and the family.”

Dave Schnarr, Executive Director of the Centre for Family Business in Waterloo Region, told Exchange that this categorization is appropriate: “I believe that these five cover the models of family businesses.”

Baron and Lachenauer state, “It’s critical to periodically revisit how you own your family business – particularly during times of transition. Holding on to the model that worked beautifully in the previous generation can threaten, or even kill, the business in the next generation. It can also put an impossible strain on family relationships.”

The five models of family business

“Perhaps the simplest model replicates the role of the founder – it keeps ownership control in one person (or couple). This model, which we call owner-operator, can be successful for many generations.”

“For other owners, the partnership model works well. Partnerships are unique in that only leaders in the business can be owners and benefit financially from it.”

Their third category is “a distributed model where ownership is passed down to most or all descendants, whether or not they work in the company.”

They add, “Still another option for family business owners is the nested model: Various family branches agree to own some assets jointly and others separately.  This model – nested in the sense that smaller family ownership groups sit inside larger ones – is particularly attractive when conflict or differences in preferences interfere with decision-making on shared assets.”

Their fifth option is “the public model, where at least a portion of the shares are publicly traded, or where a family business behaves like a public company even though it remains privately held. Whether shares are publicly traded, or not, the business is run by professional managers, and the owners play a minimal role, usually limited to electing board members.”

Schnarr says that these five approaches to ownership and management will all have their place, depending on the nature of the company – and the nature of the relationships between the family members. He told Exchange, “I feel that it depends on the type of business and the family players and, of course, the family history. No one model fits all. One may be better in a particular situation or time. Strategically looking at these approaches on a regular basis is also very key process to determine which fits best at a particular time. The family business may decide that going public might be appropriate at a certain time in their history.”

“A study of 25,000 publicly traded companies from 1950 to 2009 found that, on average, they lasted around 15 years, or not even through one generation. In this context, family businesses look pretty enduring.”

The two American authors and Schnarr agree that family businesses do not remain static; their needs and their best approach to ownership and management may change, over time – even the family unit itself may change… and may be expanded to include non-family members who have played important roles in a family business.

Schnarr says, “I am not sure that the definition of family is changing, but it certainly is expanding to include nieces, nephews, cousins, etc. It may even include long time service employees performing key roles.”

Schnarr believes that family businesses may be resistant to changing their organizational model… and that this may be a mistake, in the long term. He says, “Models for family businesses can be fluid, but many are fixed depending upon how long the leading generation continues to play a key role in the organization. It would take a family business with strong leadership and a detailed strategic plan to make any changes.”

Baron and Lachenauer believe that some family business do not adopt needed changes because they are not aware of their options. They wrote, “The lack of awareness that family business ownership requires a set of choices is perhaps the greatest – and most harmful – misconception in the field of family business. Indeed, a failure to understand your ownership options can ultimately cripple your business, causing it to lose its competitive advantage, even resulting in buy-outs or sales that nobody really wants.”

In their article in The Harvard Business Review, the two American experts highlighted some of the challenges and situations that family businesses can face – situations that demand change, whether or not that change is forthcoming. They point to businesses where some family members are actively engaged, and see other members – who own a piece of the company but are not active in the business – as “free-loaders”. They also noted the reverse issue – the “free-loaders” can consider the working owners as “robber barons”, drawing large salaries.

They noted one business owned by four third-generation brothers; three invited their sons to enter the business, but (incredibly in this day and age) tried to block the fourth brother’s daughter from joining. The brothers were implacable, and the family business was sold.

“No one model fits all. One may be better in a particular situation or time. Strategically looking at these approaches on a regular basis is also very key process to determine which fits best at a particular time.”

The authors contend that such negative outcomes are not inevitable, but solving stalemates and conflicts depends on a willingness on the part of the family members to allow their organizational structure to be flexible. The writers conclude:

“There’s no natural progression from the owner-operator model to the public model. Owners can, and do, move back and forth between models. We’ve seen ownership groups shift even very large companies from the public model to the distributed model. Of course, moving to a different ownership model involves big changes in governance, legal structures, and family relationships. That’s not easy. But adopting a new ownership model can help owners unlock a family business that’s become very stuck. It may also be the one thing that can keep your family together.”

This century is a family century

Despite Baron’s awareness of the dangers of family businesses getting stuck in stubborn situations, he is very optimistic about the potential for success by family businesses. In fact, he has written another article for the Harvard Business Review, entitled “Why the 21st Century Will Belong to Family Businesses.”
He begins by refuting the significance of the famous statistics about three generations – that 30% of family businesses make it through the second generation, 10%-15% through the third, and only 3%-5% through the fourth generation. He says, “Let’s put it in perspective. How many companies of any kind are still around after the equivalent of three or four generations? A study of 25,000 publicly traded companies from 1950 to 2009 found that, on average, they lasted around 15 years, or not even through one generation. In this context, family businesses look pretty enduring.”

He thinks that this reality will be strengthened in the coming years, because he sees family businesses having “innate strengths over other forms of ownership.”

Baron believes that changes in the overall business community have shifted the advantage to family businesses. In the 20th century, he argues, “oceans of opportunities” meant “winning strategies revolved primarily around size,” so “public companies had a clear advantage in the scale economy.”

Not any more, he says. “The qualities often associated with family businesses that were a handicap in the previous century are turning out to be powerful sources of advantage, giving them the potential to be more adaptive to the increasingly intense competition that all businesses are facing.”

Baron identifies five areas of advantage for family business in the 21st century.

He says that the focus for employees has shifted from “mass employment to a higher calling” – that a company’s ability to retain large numbers of employees is no longer key; instead, employees are looking for “intrinsic value.”

He sites a Bain & Company study: “Employees 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.”

A second advantage for today’s family business, says Baron, is a shift away from using “other people’s money” to using “captive capital.” Investment by outside funders, he argues, brings undue pressure for immediate gains. In fact, in study of leading public company CFOs carried out by the Journal of Accounting and Economics (2005), it was found that 78% of these CFOs would be willing to make decisions that destroy value in order to achieve their quarterly earnings targets!

In contrast, family businesses tend to “think in generational terms – in decades rather than quarters or years,” says Baron.

This means that “family equity can come at a very low cost of capital, where businesses can meet the annual needs of their shareholders without having to worry about paying back the principal. What’s more, since the money at stake is their own, family businesses tend to be cautious in their spending, and the discipline that comes from frugality is a tremendous advantage when topline growth is harder to achieve.”

Baron believes that family businesses are inherently suited to business life in the 21st century, with a natural bent away from profit motive, toward sustainability. He writes, “Family businesses have a big head start in building a ‘sustainable footprint.’ There is often a personal connection between the family and the communities in which it operates; reputations matter to families. Investments in the community are likely to have social rationale in addition to an economic one.”

“Holding on to the model that worked
beautifully in the previous generation can threaten, or even kill, the business in the next generation.”

The fourth advantage held by family businesses is that they tend to be much smaller than many of the 20th century corporate “behemoths”. Those giants, he says, are ill-suited to the new reality, where “companies will need to build the capacity for flexibility, adaptability, and quick/decisive action in response to shifting market conditions.”

On the other hand, he argues, family businesses “tend to have nimbler and flatter structures, where information flows quickly and easily in to the leaders and decisions come out.”

The fifth positive distinction favouring family businesses today, says Baron, is while in large corporations, there is “separation of powers” – where ownership and management are not one and the same, leading to all manner of disconnects – in family businesses, the norm is “engaged ownership.”

Baron concludes his article by contending that family businesses that manage these advantages “are well placed to make the 21st century a family business century.”

What if you’re not family?

Baron and Lachenauer have also written thoughtfully about those who might be the “forgotten people” in family businesses – the employees, especially senior employees, who are not family members, and are not among those occasional outsiders who are effectively invited to become family members, for business purposes.

Again, in the Harvard Business Review, the two authors published an article entitled “Surviving in a Family Business When You’re Not Part of the Family”.

Because not all family businesses are created equal, the ownership, operational and governance models must also be diverse.

They begin the article by stating, “Families can be intensely political organizations, and non-family executives must know how to play politics both in the business itself and in the dangerous borderland between the business and the family.”

And they offer some survival advice to non-family members, beginning with the suggestion that you “play in your ‘room’ only” – in other words, stick to the “management room” and don’t get involved in family issues – including family fights over leadership or company policy.

They also recommend being “highly discreet and competent”. They state, “the best way to avoid being left out of critical conversations is to demonstrate your competence.”

Their third recommendation is “avoid proxy wars” – do not become aligned with one rival side in family disputes.

Baron and Lachenauer also say, “Give credit and invoke the family’s higher angels” – learn to deflect credit from yourself to the family, and remember that “most family owners are intensely proud of their companies. When negative family politics break out, you can nudge the family members to remember their family’s greatness.”

They also suggest, “make use of impartial outsiders” to give feedback to family member executives on their performance, to keep yourself outside what may be a confrontational loop. And finally , the two American family business advisors say, “Know your genetic limits” – “You are biologically disadvantaged and have to be savvy enough to recognize this fact. Always be thinking about the family tree and family dynamics when considering your own path up the career ladder.”

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ISSN 0824-45
Copyright, 2018.