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Economic dominance through bloodlines

Scott McCulloch is Editor of Families in Business magazine.

In election years US presidents have often touted the benefits of family values as a potent agent for a better America. But values, it seems, are also good for jobs and the wider economy

Family-owned businesses, a Harvard Business School leaflet once stated, are becoming more, not less, prevalent. It stands to reason. If Europe is anything to go by, where family companies are outperforming their rivals on all six major stock indexes, there is something to be learned from them.

But what of family business in the US? "A large portion of independent businesses are family-run, and independent businesses return much more money to the local economy than corporate-owned companies," says Jeff Milchen of the American Independent Business Alliance. "Beyond economics, family-owned businesses help to make a community special and distinctive."

More than 24 million family-owned businesses operate nationwide, with family firms representing 64% of GDP, reports the Raymond Family Business Institute. According to the 2003 study, co-sponsored by the Raymond Institute and Mass Mutual Financial Group, US family-owned businesses are experiencing robust growth despite difficult trading conditions. The report found that the mean revenues of the 1,143 family firms surveyed have grown to $36.5 million, up more than 50% since 1997.

American family businesses are also slow to lay off employees in hard times, plan better, and provide more opportunities for women than non-family run firms. There is little doubt, says Joe Astrachan of the Cox Family Enterprise Center, that family-owned and operated businesses are large contributors to the US economy. "However, just how to determine the exact extent of their impact is difficult," he adds.

Difficult but not impossible. A study last year by the Journal of Finance had a crack at it. It found that US family run businesses are 5–6% more profitable and tend to be valued 10% higher by the stock market than their non-family run counterparts. "The notion that large, concentrated shareholders are inherently less efficient is not a universal view," says Ron Anderson, co-author of the 28-page analysis which tracked the performance of 403 family firms via the Standard & Poor's 500, a share index widely regarded as a bellwether for the US equity market.

The report found that US family firms comprise 35% of the S&P 500, with families themselves retaining on average 18% of their firms' outstanding equity. But family control and influence is often far more potent. In firms where the family does not have outright majority owner­ship, their control of the board seat is 2.75 times greater than their equity stake would suggest.

Anderson and the report's co-author, David Reeb, point out that because family wealth is often closely linked to a firm's welfare, families have strong incentives to monitor managers. Founding families also maintain a long-term presence in their firms. The DuPont family has held a substantial equity stake for over 200 years in the firm bearing its name. That means families potentially have longer horizons than other shareholders and willingness to invest in long-term projects. Anderson and Reed believe they "suffer less managerial myopia" and are less likely to forgo strategic investments to boost current earnings. Also, the legal protection extended to minority shareholders in the US suggests that those families maintaining a presence in the firm – rather than selling out – may provide a competitive advantage.

Absolute power corrupts?
Of course there is a downside. With substantial ownership and cashflow rights, founding families have the incentive and power to take action seen to be self-serving or at the expense of the firm's performance. Anderson and Reed argue that, on one hand, diversified (smaller external) shareholders are presumed to evaluate investments with a view to maximising the value of the firms' cashflows. On the other hand, large concentrated shareholders (the family members) may see greater benefit in enterprise growth or survival than from increasing share value. Large ownership stakes, they add, can reduce the probability of bidding by other agents, but reduce the value of the firm.

But what do family firms contribute to US economy in actual terms? That, says Astrachan in a report gauging the links between the two, depends on how you define a family business. The market value varies wildly, between $2.6 trillion and $5.9 trillion. Put another way, family firms account for 29-64% of the US's $11 trillion economy. Astrachan and his co-author Melissa Carey Shanker of Loyola University boil this down to three definitions: broad, middle and narrow. "Broad" is the most inclusive, sucking 62% of America's 82 million-strong workforce and 89% of business tax returns into the family business definition.

"This definition covers the gamut of possibilities, from a large company that has descendants from the original founding family as stockholders or on the board to an independent building contractor whose daughter manages his books and whose grandson performs occasional manual labour for him," says Astrachan.

Meanwhile, the "narrow" definition, which involves multiple generations and family managers, suggests that US family business comprise just over a quarter of the workforce – 36 million people in 3 million companies – pumping a disproportionately high 29% or $2.6 trillion worth of goods and services into the US economy in 2000.

Either way, American business families are inextricably linked to the domestic economy. Good or bad? The answer is both. One of the greatest costs that large family shareholders can impose, say experts, is remaining active in management even if they are no longer competent or qualified to run the firm. Conversely, the long-term nature of founding-family ownership means suppliers or providers of capital are more likely to deal with the same people for longer periods in family firms than in non-family firms. A consequence of maintaining a long-term presence is that the firm will enjoy a lower cost of debt financing compared with non-family firms.

One reason for the success of US family businesses is they typically carry less debt than non-family-owned companies, says Elaine Allen, chief analyst for the Raymond Institute study and an associate professor of maths and statistics at Babson College. Family companies also tend to be involved in manufacturing, construction and a variety of service industries, which have not been hit as hard as other sectors of the economy such as the TMT triumvirate – technology, media and telecoms.

How can non-family businesses emulate these successes? Family business are committed to keeping the company going, says Carol Wittmeyer, vice president of Institutional Advancement at Medaille College in Buffalo, New York. A potent combination – passion and commitment – is the engine powering success, she says. And the fuel? In a word: liquidity. US family businesses are cash-oriented – one in four carry no debt. But in terms of embarking on an aggressive expansion programme, this is not necessarily shrewd, say experts. "They may also be under-leveraged and failing to optimise their growth opportunities," the Raymond report speculates. "If taken as a whole, the findings show tremendous untapped economic opportunities awaiting appropriated stimulus."

One thing is certain: American entrepreneurial families have always been at the heart of the capitalist system. "The general rap on nepotism is inaccurate," points out Adam Bellow, a family business expert and author. If the world's foremost economy is anything to go by, he's probably right.

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