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Why the family is the future

In his essay That Politics May Be Reduced to a Science, the Scottish thinker David Hume asked himself whether good government is down to the “humours and education” of the rulers, or the form of the constitution. We might ask the same question about businesses.

In his essay That Politics May Be Reduced to a Science, the Scottish thinker David Hume asked himself whether good government is down to the “humours and education” of the rulers, or the form of the constitution. We might ask the same question about businesses. What is the best model for a company? Or is success down to people?

For many years most investors and lenders have preferred 100% publicly owned companies. But such businesses are rapidly falling out of fashion. Investors are turning away from equities. Shareholders are mutinying. Emerging countries such as China and Russia are backing state-owned businesses, evidently believing that leaving your national prosperity in the hands of mercurial private companies is madness.

This should leave family businesses in a strong position for three reasons. Firstly, banks have traditionally seen family businesses as overly conservative – over the past 25 years they didn’t give the eye-popping returns that publicly traded companies so often did.

But that reasoning now looks dodgy. One reason that publicly owned businesses flourished in that period was exactly that banks were lending to them willy-nilly. We have just come out of a quarter-century-long credit boom. Bankers lent to publicly owned companies because they believed they would be more successful. But that’s a self-fulfilling prophecy. Decide that model X will do better than model Y. Lend to model X. Hey presto, it does better.

Secondly, the metric for success has changed. For years share price was the holy grail for investors. A company that paid a dividend was frowned on, because it was not directly reinvesting profits in the business. Businesses allowed their strategies to be dictated by the market. Or, in fact, the market’s theories about what would bring profits in the future. Share-price appreciation was often not based on actual profits, but the prediction of future profits. But if instead we see stability and longevity as signs of success, then family businesses suddenly look more appealing.

Thirdly, family businesses were often frowned on because they tend to promote family members who are supposedly less talented and successful than the big shots of the corporate world. But we know now that what that “talent” and “success” amounted to was all-too often a fixation on the sorts of profits that depended on credit. Change your definition of talent or success, and your evaluation of those people changes too. Managers with a slow and steady approach no longer look so daft.

Family businesses are not perfect. They are less transparent than publicly owned companies, they can be less ambitious and numerous studies show that they often are less well managed than other types of business. But they have upsides. They are specifically designed to withstand disasters; they are not susceptible (or as susceptible) to stock market speculation or volatility; and they tend to have tightly-written constitutions that put the brakes on excitable managers. What were once seen as weaknesses should actually be seen as strengths.

Hume thought that good governance came from a constitution with enough checks and balances to stop bad people ruining things. That seems like the definition of a good family business. Let’s hope banks work that out soon, and start writing cheques.
 

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