Family business in Germany

Peter May advises family businesses in conceptual issues. He is Professor of 'Mittelstand' Business Studies at FHDW in Bergisch Gladbach and founder of the INTES Academy for Family Businesses and the INTES Advisory Services for Family Businesses in Bonn, Germany.

Germany has lagged behind other European countries in its treatment of family businesses. Perhaps if there were less confusion with the definition of a family business, their renaissance could further flourish

Family businesses are currently back in fashion in Germany. Not so long ago, at the peak of the new economy hype, they were still being condemned as boring and hopelessly backward. Now even manager magazin, one of Germany's leading business publications, is celebrating the "renaissance of the family business". "Once considered old hat, they are now the latest model...

At well-run family businesses:

- they think strategically for the long term;
- owners are willing to put up with occasional lean years;
- stable ownership protects them against undesired take-overs;
- management continuity creates a feeling of trust with customers and employees;
- a relatively flat hierarchy and uncomplicated decision-making mean greater flexibility."

On the other hand, people never tire of stressing the disadvantages of family businesses. Limited access to the capital markets, diffuse organisational structures and responsibilities, lack of separation between family and company affairs (nepotism) and succession problems all come in for criticism, and not just by manager magazin.

What is it then with family businesses? This is not so easy to answer as there is surprisingly little literature on the subject in Germany. There is even disagreement over the term. Many writers insist that ownership and management have to be in the hands of one person or one family, while others are satisfied if the family leaves its mark on the company.

Mittelstand vs family business
The much maligned cause for this widespread confusion is little-known but not difficult to work out. Other countries split companies up into "small- and medium-sized enterprises/large companies" versus those that are family-owned and those that are not, thus separating the quantitative and qualitative grounds for differentiation. But the discussion in Germany is dominated by the term "Mittelstand". The general definition of this term includes all companies with sales of less than €50 million and less than 500 employees. An additional qualification is that such companies must be wholly or largely owned by independent entrepreneurs or families who also manage them. Mittelstand accordingly combines both quantitative and qualitative attributes for differentiation. As far as we can see, this is unique in the world – apparently a throwback to the historical middle class ("mittlerer stand") of independent craftsmen, merchants and professionals.

So what? one might well ask. After all, the more than two million German companies that meet the quantitative criteria for classification as mittelstand companies are overwhelmingly owned by one person or a family. In contrast, large companies increasingly consist of anonymous joint stock companies.

Anyone thinking this means we can do without an additional breakdown into companies that are family-owned versus those that are not is nevertheless making a serious mistake – because this way of looking at things completely leaves out the large family businesses. They do not feel like the large companies run on strictly capitalist lines as their attitudes and ways of addressing problems are too different; but the mittelstand, to which they feel they belong emotionally, excludes them by definition. Based on IfM's assumptions, this affects about half of the 6,000 large companies in Germany. Approximately 3,000 large companies, include giants like Aldi, Tengelmann, Bertelsmann, Henkel, Haniel, Heraeus and Würth, certainly cannot be considered simply as anomalies falling between two stools whose problems and interests can be safely ignored.

But this is just what happens in Germany. Large family businesses are hardly mentioned in politics. Political discussion, if any, concentrates exclusively on the mittelstand. We have mittelstand policies but no family business policies. That is fine for those who count themselves as mittelstand but bad luck for the others.

The following example illustrates this problem. The main aim of the German government's 'major tax reform' in 2000 was to get rid of the disadvantages burdening joint stock companies based in Germany compared with those in other countries. Capital markets had shown their disapproval of these disadvantages. To this end, the government significantly lowered income taxes on profits retained by companies and on dividends. So as to prevent private companies being too heavily disadvantaged, the government originally intended to give them the option of being taxed as a joint stock company without actually having to change their legal form. This was an attractive proposal for the large family businesses. In the past, they had chosen the legal form of a private company not only because it was more attractive from a tax perspective but also because they wanted to avoid the co-determination by elected workers that usually came with becoming a joint stock company. The option would have let them remain as private companies and so continue to combine the advantages of optimal taxation with freedom from co-determination.

The interests of the small- and medium-sized enterprises, however, were different. As freedom from co-determination was not an issue for them (it does not affect companies with less than 500 employees) and as they found the costs connected with taking up the option too high, they concentrated their efforts on achieving a few improvements in the taxation of private companies that were relevant to the mittelstand. In the subsequent negotiations, the option was sacrificed without engendering any noticeable opposition. How could it have? The mittelstand achieved its goals, at least in part, and the large family businesses in Germany have no lobby.

Family businesses outside Germany learned this too, when they recently formed GEEF (Groupement Européen des Entreprises Familiales), a broadly based group to represent the interests of family businesses at a European level. There is no political association in Germany acting as a strong representative of the interests of all – including specifically large – family businesses at a national level. Instead, GEEF had to select from the competing mittelstand associations. Ultimately, the ASU (Association of Independent Entrepreneurs) was chosen, which started admittedly as a club for entrepreneurs but, judging by its membership structure, has long since mutated to a typical mittelstand association of mainly small- to medium-sized companies.

On the issue of scientific research into the subject of family businesses, German entrepreneurs are again left looking enviously at their European and overseas counterparts. Whereas family business research has long been a recognised discipline, especially in the USA, and is carried out in many universities and other research institutes, Germans have to be happy that there is at least one institute in Witten-Herdecke that performs research on the subject. The pile of scientifically reputable literature is correspondingly small. The first textbook ever on the subject of family businesses was not published until 2000. Family business consulting, another subject that has long been established elsewhere, is still in its infancy in Germany.

The reason for this is once again the German fixation with the mittelstand. There are plenty of research and academic institutes in Germany, such as INMIT in Trier, dealing with mittelstand issues. Occasionally they will even offer business studies courses concentrating on mittelstand business. However, problems typical to family businesses are only covered here insofar as they relate to the mittelstand. Large family businesses are once again left in the cold.

The future
The typical narrowing of the definition of the term mittelstand in Germany can thus be seen to put family businesses as a whole at a disadvantage. This is a good enough reason to suggest here that we drop this useless national anomaly and for Germany also to classify companies in the future on the basis of quantitative and qualitative criteria, ie size and ownership structure. The advantages are obvious:

Revise definition. We could finally file away the unpromising debate about the term "mittelstand". Many people, on being asked about the correct definition of mittelstand state that the mittelstand includes anyone who thinks in a mittelstand way. Instead of promoting the endless dispute about the correct definition of mittelstand, we should rather replace it with a new, better-suited term.

Self-esteem. German family businesses could then at last develop a feeling of self-esteem that underscores their common interests without obliterating the differences. Large family businesses would no longer have to describe themselves as mittelstand without actually belonging and being treated as such by the politicians.

Large family businesses taken into consideration. A change in terminology would mean politicians no longer taking account of owner-dominated (family) businesses solely from the point of view of small- and medium-sized companies but, at last, having to consider the interests of the large family businesses.

International involvement. At the same time, Germany could take an adult part in the international dialogue on the subject of family businesses, which is currently hampered by the restriction inherent in the term mittelstand.

Research. In the matter of research and services related specifically to family businesses, Germany could also catch up with international standards, as the issues typically facing large family businesses would at last come under scrutiny by researchers.

Regardless of their size, family businesses have many common interests resulting from being in the hands of a dominant entrepreneur or family. But there are also differences arising from the different sizes of these companies.

Succession issues. A constant problem that is both difficult and significant for family businesses is good succession planning. Every year, 70,000 to 80,000 German companies have to sort out this problem – an economic issue of national dimensions. And it affects large family businesses as much as small- and medium-sized. But with different emphases. Whilst small- and medium-sized enterprises find it increasingly difficult to find a successor who is willing to take on the parental company, the problem in large companies is much more often the suitability of the successor. The bigger the company, the bigger the shoes that the successor has to fill and the smaller the likelihood that a family member of the owners is going to be capable of doing so. Some owners of large family businesses like Haniel and Albrecht (Aldi Süd) have even drawn the legal consequences of this and had their company's articles rule out future generations of family members managing the family business.

Even the problems connected with the lack of a willing or able member of the family to take on the company are not identical for large family businesses compared to small- and medium-sized family businesses. Whilst large family businesses can generally fall back on managers from outside the family (another subject that has not been sufficiently researched in Germany), this option is often ruled out for small- and medium-sized family businesses, if only due to costs. In these cases, they are often only left with the choice of selling or closing down the business.

Holdings transferral. The problems related to transferring holdings in the company are also different. Small- and medium-sized enterprises are generally passed on to a single successor who will actively manage the company. These companies would not be able to stand a split between several heirs. Researchers and consultants often recommend this kind of "crown prince" solution to owners of large family businesses but few want to follow such a recommendation. As splitting the shares in the company will not lead directly to the company's ruin, owners prefer not to show a preference for a particular child by handing over the company in one piece to him or her.

Family management. That decision creates problems in the future. This is because the gradual fragmentation over the generations of the shares in the company leads to an increasing divergence of interests and thus to a growing potential for conflict between the company's shareholders. "How do I manage the family?" is therefore almost exclusively a question for large family businesses. But they have to face it because a family business without professional 'family management' can hardly survive for long. Family businesses get into trouble much more frequently as a result of arguments between the family shareholders than because of management errors. But family management does not yet have a long tradition in Germany. In this country, people still believe that articles laid down by the family patriarch can keep the family under control. The fact that this belief is mistaken is well documented by the frequent family feuds between members of well-known families such as Bahlsen, Wünsche, Faßbender (Arag) and Herz (Tschibo).
 
Company finances. The reorganisation of company finances due under the heading "Basle II" presents family businesses with a new challenge. Related risks have to be taken more closely into account in the future when loans are granted. The negative consequences tend to affect small- and medium-sized enterprises significantly more. On the one hand, large companies are more likely to be able, on account of their size, to take advantage of alternative financial instruments. On the other hand, banks consider small- and medium-sized enterprises, on average, to be riskier. And not without reason, as  their structure is frequently not very professional. All too often, everything revolves around the individual running the company. There is little sign of what should happen when he is not there – such as a written strategy that can easily be understood by outsiders. The question of the succession is seldom settled and the company's structure is more often based on ways to avoid paying tax than on the basic requirements of proper corporate governance. No wonder these companies do not do so well when it comes to ratings and the granting of loans. It is high time that smal- and medium-sized family businesses also showed more professionalism in setting up the structure of their companies.

Private assets. There are also differences over the issue of the entrepreneur's assets. Word has at least got round in Germany about how important professional management of the entrepreneur's assets is for the long-term success of a family business. Anyone who has to focus at company level ought to diversify at asset level. The consequences of this lesson can however be very different depending on the size of the company. Whilst it is generally the question of simply creating worthwhile unencumbered assets for owners of small- and medium-sized enterprises, the expression "family office" is increasingly heard at large family businesses. What has long been the practice in the USA and other countries, where there is much more of a focus on large family businesses, but seems to have been reserved for a handful of giants in Germany such as C&A Brenninkmeyer, Haniel and Heraeus, is now also being offered on a broader basis in this country. We are talking about the common, professional management of the family's private assets. The advantages are obvious. Whoever invests more assets, is given better conditions, a better spread of risks and can also afford better management. And whoever organises for the private assets of a company's shareholders to be managed in the same way, minimises the potential for conflict that results from unequal wealth. For the time being, however, the family office concept is till in its infancy in Germany. It remains to be seen how it develops over the next few years.

There are, of course, more examples of similar problems with different emphases depending on a company's size. Germany needs to treat these companies with the professionalism other countries do. An important first step would be to stop talking about the mittelstand without differentiating between small- and medium-sized family businesses on the one hand and large family businesses on the other. Family businesses, large and small, have long deserved this – because they make up by far the largest number of all the companies, provide the largest number of jobs and create the lion's share of our gross national product. Improving their overall conditions would mean improving the chances in general for German prosperity.