George Malim is a freelance journalist based in London. firstname.lastname@example.org
Family firms are not inherently big risk-takers. Responsibility sits heavily on a leader's shoulders because they will not want to sacrifice generations of toil. However, caution does not mean a company cannot be successfully competitive, writes George Malim
Family businesses, though built for sustained growth over long periods of time, are not recognised as risk-takers. There are many reasons for this, ranging from the industries they operate in to the weight of responsibility felt by second or third generations to preserve the health of the business they inherited. This onus on preservation can mean that opportunities for expansion are missed and ultimately family businesses can fail. However, the same is true for businesses that have taken excess risk and the graveyard of family businesses is littered with the tombstones of businesses that have over-reached themselves.
Family members of second or third generation businesses are cautious about risking the business their parents built up through years of toil by moving swiftly to raise funding to expand the business. There is often a fear of raising funding in any way that could result in loss of control of the business, which means fund-raising routes such as most venture capitalists and IPOs, are off the agenda because both types of investor are usually looking for a return on their investment within five years. The exit these sorts of investors are looking for is most likely to be a disposal and that runs counter to the ethos of most businesses.
Instead, family businesses often appear to prefer to operate in a fund-raising 'safe mode' whereby growth comes from organically raised funding or ultra-conservative financing, such as bank loans. The reasons for this are simple, says Andrew Godfrey, international family business consulting director at Grant Thornton. "Many family businesses find it difficult to cope with outside investors because the objectives of venture capitalists or public investors are at odds with the aims of the family. However, it is too simplistic to say family businesses always operate in 'safe mode'. It depends on the nature of the industry they're in and many businesses have reserves of 'patient capital' to drive expansion."
IMD professor John Ward thinks family businesses get a bad press and the well-run ones are as astute as their non-family-owned counterparts. "Successful family businesses are prudent, as well as conservative," he says. "They know, because continuity and inherent value are important. Going public and major acquisitions are often imprudent, based on the fear of fads and conventional wisdom. By and large, well-managed family businesses don't miss much, although in the short-run one might think so."
One reason for the perceived caution of family businesses is the multi-generational effect. Family businesses, by definition, are established by patriarchal – or matriarchal – entrepreneurs who develop businesses based on their own acumen. However, these pioneers seldom pass on their own entrepreneurial spirit to the second generation and often neglect to train their successors adequately, failing to ensure they gain experience outside the business. Consequently, the second generation often pursue a highly conservative line because they either don't have the skills to develop the business or are afraid of damaging the good work of their parents. This isn't necessarily a problem so long as the market addressed by the business established by the parent doesn't change during the stewardship of the son. If things remain the same, the processes and structures put in place in the first generation can continue unimpeded in the second generation without the need for change being foisted on the unprepared or unwilling.
"Family businesses are driven by the leaders that happen to be in the right position at the time," says John Freeman, a partner at consultancy Business Analytics. "It's a generational issue. The entrepreneurial nature of the first generation makes it unlikely that the second generation will be as entrepreneurial. They're more likely to caretake and do what they have been told and are not necessarily prepared to run the business. This is what normally prevents changes although the only real danger from this is if the market changes from the first generation to the second generation and the second generation doesn't have the ability to change the business."
Freeman points out that this issue is often resolved by the third generation as the second generation seeks to avoid the mistakes of the fathers by ensuring their children are properly prepared. In addition, claims Freeman, the entrepreneurial cycle often reasserts itself in the third generation. However, Freeman warns that only around 7% of family businesses make it to the third generation.
Ward disagrees that generational issues are responsible for the turgid approach to business of subsequent generations. "Continuity makes family firms prudent," he says. "Sometimes insecurity by the next generation leads to imprudent risks but this is not generally the case. Family firms are competitive. It's wise to bet on the tortoise and not the hare."
In addition, Ward favours strong management to mitigate risk and encourage development of the business. "The best thing family businesses can do to challenge their thinking on the prudence versus growth question is to have a great, independent board of directors."
Godfrey, at Grant Thornton, says the issue of inappropriate or inadequate management can be addressed by bringing in talent from outside the business. However, this is fraught with difficulty and can cause boardroom schisms. "Instilling aggression into the family business is about attracting the right people – aggressive strategy is mostly about getting the right people in place," he says. "But you have to think carefully about integrating non-family members into the business. To me the risk factor in an acquisition, for example, is in managing the aggressive strategy without the management in place to manage the risk."
"Family businesses sometimes don't pay enough attention to strategic planning and that can cause them to go to sleep," said Godfrey. "They don't think about where they want to be in five years' time because they assume they'll plod on as usual."
Family businesses are often branded unadventurous but there may be other reasons for their caution. For example if three siblings are running different divisions of a family business and are in fierce competition with each other, the two brothers might block the other one's expansion plans. In addition, non-executive family members may be reluctant to see their payments from the business decrease to raise funds for expansion.
In essence, the bad press family businesses get when it comes to their conservative nature is composed of a set of circumstances. If the industry a business operates in is well suited to the family business model, the management of that business is much freer to be aggressive and take risks. For example, a business such as a private bank, land owner or a Scotch whisky distiller is in a strong position. These businesses have significant assets that can be used as collateral for traditional bank loans and solid markets for their products. In addition, these markets do not undergo massive change. This means they're in a strong position to handle growth organically.
"I think, provided they have sufficient capital these sorts of business can be as aggressive as anyone else," says Godfrey. "The constraint is raising capital but in an industry that doesn't require much capital or is self-sufficient that's not a problem. For example, with global construction equipment manufacturer JCB, there's no reason to believe they're less aggressive than anyone else. In addition, business with substantial assets can be aggressive, too. Banks are taking a more commercial view in backing family businesses so will often provide capital to longstanding family businesses. If the industry is suited to a family business and if that business is asset rich it will be able to raise finance."
Freeman adds: "If you have a company that's like the Daily Mail General Trust you have baskets of money to play games with. But if you're a £7 million family business with two or three brothers running it you don't necessarily have the pay and benefits available to attract top external management."
However, businesses that, for example, are in commodity manufacturing have little choice but to change. In these cases the family needs to either form a partnership with a company that operates in a low-cost manufacturing market such as China, develop cheap manufacturing capacity of its own or sell-up and realise its assets.
Godfrey gives the example of a family food business started four generations ago. Between the current and previous generations the family split and disposed of the business. Two brothers went on to create a new business that now has a £400 million turnover – something to pass on to the grandchildren.