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94 Keeping the family in business Heinz-Peter Elstrodt Very few large family-owned enterprises thrive beyond the third generation. Those that do ﬁnd ways to run themselves professionally while making the family happy. I n advanced economies, as well as in emerging markets, most compa- nies start out as family-owned businesses. From their humble beginnings, driven by entrepreneurial vision and energy, some have grown to become major forces in their economies. Indeed, this still happens not only in emerg- ing markets, with their chaebols in South Korea and grupos in Latin America, but also in North America and Europe, where relatively young family-owned
95 PHILIPPE WEISBECKERbusinesses such as Wal-Mart Stores, Bertelsmann, and Bombardier, to namejust a few, have become front-runners.But family-owned businesses—companies in which a family has a control-ling stake—face a sobering reality: the statistical odds on their long-termsuccess are bleak. In fact, a number of studies, taken together, suggest thatonly 5 percent continue to create shareholder value beyond the third genera-tion. This statistic should come as no surprise, given the business challengesany company faces in increasingly competitive markets, to say nothing ofthe difficulty of keeping growing numbers of family shareholders committedto continued ownership. One kind of risk for these businesses comes fromthe generations that follow the founder, whose drive and business acumenthey might not match, though they may insist on managing the company.By the time the third generation takes over, the scene is set for squabblesamong members and branches of the ever-expanding family. Rather thanlooking after the interests of the business, they may ﬁght over the size of thedividend payouts, the composition of the board, or who gets to be chiefexecutive officer.Nevertheless, a few family-owned businesses defy the odds and continue tothrive generation after generation. To gain a better understanding of how to
96 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 3 N UM B E R 4 build and manage family businesses that last, McKinsey conducted inter- views with the family leaders—either the chair of the board or the leader of the family holding—of 11 family-owned businesses. Of these, 9 were in the United States and Europe and 2 in emerging markets, where such busi- nesses make up a much larger part of the economy but are mostly quite young. All of the companies are at least 100 years old—the youngest in its 4th generation, the oldest, founded more than 250 years ago, in its 11th. These survivors are not only venerable but also large and successful. Of the 11, 7 have revenues of more than $10 billion, and the families that own 6 boast a net worth of more than $5 billion each. All have delivered growth and proﬁts over recent decades and are ﬁnancially solid, with low debt-to-equity ratios. The companies in our sample—a few of them public—have made it through economic depression, war, and other forms of turmoil, with the families remaining in control. Their experience has great value for younger family businesses whose owners face a generational transition and must decide whether and how to embrace the challenge of creating an enduring business under family control. For the companies in the sample, the key to survival and success was strong governance in its broadest sense: a powerful commitment to values passed down through the generations and a keen awareness of what ownership means. Ownership is both a blessing and a curse, giving the family the power to destroy the business as well as to shape it and enjoy its returns. The fami- lies that own the businesses in the study recognized this danger and estab- lished systems of checks and balances for carrying out the family’s roles in the three vital dimensions of governance: ownership, board supervision, and management. In what is usually a patchwork of oral and written agreements—some legally binding, some not—the family addresses issues such as the composi- tion of the company board and how it should be elected; which key board decisions require a consensus, a qualiﬁed majority, or interaction with the shareholder assembly; the appointment of the CEO; the conditions in which family members can (and cannot) work in the business; how shares can (and cannot) be traded inside and outside the family; and some of the boundaries for corporate and ﬁnancial strategy. These arrangements, typically developed over many decades, help defuse the often highly charged issue of the succes- sion of power from one generation to the next and lay the foundation for fulﬁlling the two main conditions for the long-term success of any family- owned business: professional management and the family’s ongoing commit- ment to carry on as the owner.
K E E P I N G T H E F A M I LY I N B U S I N E S S 97Running the business wellWith a set of clear rules and guidelines as an anchor, and with family con-ﬂicts comfortably at bay, family-owned enterprises can get on with theirstrategies for long-term success. Some key factors show up over and overagain: strong boards and uncompromising standards of meritocracy in per-sonnel decisions, risk diversiﬁcation and business renewal through activemanagement of the business portfolio, and long-term ﬁnancial policies.Powerful boardsStrong boards are particularly important in family-owned enterprises tocomplement the family’s business skills with the fresh strategic perspectivesof qualiﬁed outsiders. As a fourth-generation family leader said, “We mustnot be managers. We must be experts in corporate governance.” Indeed, thecorporate-governance practices ofmost family businesses in the studysurpassed those of average public As a family leader said, ‘We mustcompanies. not be managers. We must be experts in corporate governance’Even when the family holds all of theequity in the company, its board willmost likely include a signiﬁcant proportion of outside directors. One familyhas a rule that half of the seats on the board should be occupied by outsideCEOs who run businesses at least three times larger than the family busi-ness. Another private family business set up an independent institution solelyto nominate and elect one-third of the board members. But in most of thecompanies, the family nominates and elects the outside board members.The procedures—for all nominations to the board, not just nominations ofoutsiders—differ from company to company. One board perpetuates itself:it selects new members and then seeks approval by an inner family commit-tee of around 30 members and formal approval by an assembly of share-holders. In another company, board members are elected, on the principleof one share, one vote, from a list of candidates at a meeting of all share-holders. A more common approach is for a limited number of familybranches to pool their holdings and elect a block of board members. Theformal mechanisms differ; what counts most is that the family must under-stand the importance of a strong board.All of these boards become deeply involved in top-executive matters andmanage the business portfolio actively. Many have meetings stretchingover several days to discuss corporate strategy in detail. In most of the com-panies, the chair and the vice chair typically spend at least half of their time
98 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 3 N UM B E R 4 interacting with other board members, top management, and the family, which is kept informed about the business through newsletters, informal gatherings, and regular reports. True meritocracy Nepotism is the obvious way to destroy a family-owned business in a single generation—and this happens, all the time and all over the world. To control the natural human desire to favor your own kin, family-owned businesses that want to last for generations must establish a true meritocracy, as all the companies in the survey did. Half of the families had decided not to have their members involved in man- agement at all. “Y cannot expect the family to consistently generate com- ou petent top managers,” one family leader said. Another noted, “My uncle, who had been appointed chief executive, died early. Otherwise, he would have ruined the business.” A third leader said, “Our key factor of success is that we hire the best people in the market, and if they turn out not to be the best, we ﬁre them. We would not be able to do that if we had family‘You cannot expect the family to members in management.”consistently generate competenttop managers,’ said one leader In the remaining companies, family members who have proved their competence are welcome to serve as managers. Two of the companies require family members to start work outside the family business. After they have had 10 to 15 years of highly successful experience, its board may invite them to hold top-management positions. Said one family CEO: “I was surprised to be invited to run the company, but I guess the family found me competent.” At the other companies, family members can enter the business after gradua- tion and work their way up. Their performance and career prospects are usually evaluated every year, often by competent outsiders reporting directly to the board. If such family members lack the potential to become top man- agers in the long term, they leave the company. “Our policy is up or out,” one family leader said. “Nobody gets promoted because he or she is family—rather, the opposite.” One family member and CEO of a privately held company explained in great detail how he was put through a two-year process of outside evaluation and coaching before a board committee appointed him to the position. Another company uses a recruiting ﬁrm to ﬁnd alternative, outside candidates for
K E E P I N G T H E F A M I LY I N B U S I N E S S 99every top-management position and sometimes appointsthem. Harsh as these policies may seem, they safeguardthe family’s long-term interests.Diversification strategyMost of the family-owned businesses in the study areprivately held holding companies with reasonably inde-pendent subsidiaries, which might be publicly owned,although most of the time the family holding company fully controls themore important ones. By keeping the holding private, the family avoids pres-sure from outside shareholders for quick, high returns and thus allows thecompany to pursue diversiﬁcation strategies to achieve steady proﬁtabilityand survival over shifting business cycles. This approach might not makesense for a purely ﬁnancial investor, but families that aim to keep control forgenerations have a different perspective. “We want to provide diversiﬁcationfor our shareholders within the business so that they don’t have to take themoney out and do the diversiﬁcation themselves,” one family leader said.All of the family-owned businesses surveyed see themselves as conglomer-ates, not as single-business companies. While some have a wide array ofunconnected businesses, most focus on two to four main sectors. They allseek a mix between businesses with high risks and returns and businessesthat have more stable cash ﬂows. Many of them complement a group of corebusinesses with venture capital and private equity arms in which they invest10 to 20 percent of their equity. The ability to react quickly to opportunitiesthat come up through these families’ extensive networks is important: in onecase, a timely investment of $5 million a few decades ago turned into a largestake in a $50 billion company. The idea is to renew the portfolio constantlyso that the family holding can preserve a good mix of investments by shift-ing gradually from mature to growth sectors. For the company to survive, itis necessary to focus on the enterprise as a whole and not to be sentimentalabout individual businesses. Many companies in our sample had departedthe founding core business—always a traumatic decision.In most of the companies studied, the criteria for selecting new opportunitieswere clear: asset-light businesses such as retailing, consumer goods, andtrading were preferred to asset-intensive ones, to avoid competition withpublicly traded companies that have better access to capital and—in the1990s—often favored growth over proﬁts. Several family-owned companiesin our sample exited asset-intensive businesses, though they were performingwell and ﬁtted nicely into the portfolios, for fear that they could drain offﬁnancial resources in the long term. Niche businesses—those competing in
100 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 3 N UM B E R 4 small world markets—are also popular, because they give the family control and a chance to be globally active without becoming ﬁnancially and organi- zationally overstretched. The ﬁnancial policies of the companies are consistent with their risk-averse portfolio strategy. Those in the study pay lower dividends than most public companies with similar levels of performance, because reinvest- ing proﬁts is the only way to expand a family-owned business that doesn’t want to dilute ownership by issuing new stock or to assume big amounts of debt. For many families a side beneﬁt of this policy is that members do not amass (and possibly waste) large individual fortunes but rather stay focused on their ownership role. These companies’ debt targets are conservative too, par- ticularly for the holding company, which usually aims to have a 0 to 20 percent debt-to-equity ratio. Many don’t guarantee the debt of their subsidiaries. “We explicitly tell all ﬁnancial institutions we will not bail out a sub- sidiary in trouble. This makes debt more expensive at the subsidiary level, but protecting the family’s wealth makes it worth it,” one family leader said. Long-term-performance focus These family-owned survivors share a strong performance culture combined with quantitative targets for growth and returns. One business in the study aims to have returns 25 percent above the relevant stock market index: as the company’s leader said, “Why would you keep the family business if it returns less than the stock market?” Interestingly enough, when asked about historic returns, none of the family members interviewed for the study quoted the quarterly performance of the companies or even their perfor- mance over 1 or 2 years. The minimum period mentioned was 5 years, and one to two decades was more common. Over the past 10 to 20 years, most of the companies have enjoyed shareholder returns at or above those of stock market indexes. Economic cycles are a fact of life for family-owned businesses that have a very long past and anticipate an even longer future. “We have survived world wars and hyperinﬂation. We never expect good periods to last very long; nei- ther do we expect that from bad periods,” one family leader said. To sum up, these companies are performance oriented but risk averse, which might make them less successful in boom times but keeps them alive, with healthy prof- itability, over the very long term.
K E E P I N G T H E F A M I LY I N B U S I N E S S 101Keeping the family happyNo family-owned business survives for long unless it is run professionally.But ensuring that members of the family want to carry on as owners genera-tion after generation is equally important.Outsiders may wonder why the family should bother with all the hard work;why not sell the company and let each family member invest the proceedson capital markets? Leaders of family-owned survivors often argue that apooled and professionally managed fortune stands a better chance of surviv-ing and growing than it would if it were split, sometimes into hundreds ofparts, each invested separately. That is an arguable point, and not all familymembers agree. But family-owned businesses undoubtedly offer noneco-nomic beneﬁts too: a respected position in society, the pride and the senseof belonging that come with carrying on a family tradition, and the chancefor some members to work in thebusiness and for others to pursueshared interests alongside it. Leaders of family-owned survivors often argue that a pooled andSuccessful old family-owned busi- professionally managed fortunenesses have found many ways to hold stands a better chance of survivalfamilies together as owners. Privateownership serves as an incentive forfamilies to stay with companies by allowing them to pursue diversiﬁcationstrategies that make it safe to keep most family wealth at home. It also func-tions as a disincentive to exit because there is a large market discount—often 20 to 50 percent of the estimated economic value—for the shares ofprivately held companies as a result of low liquidity and the frequent lack ofvoting rights.To counter nonfamily ownership, many family-owned businesses also restrictthe trading of shares. Family shareholders who want to sell must offer theirsiblings and then their cousins the right of ﬁrst refusal. In addition, the hold-ing often buys back shares from exiting family members through a shareredemption fund. One company decided generations ago that shares couldbe sold only at prices well below their book value (usually two to three timesless than the estimated market value) and only to other family members.Indeed, at the core of a durable family enterprise is the philosophy that own-ership implies, not necessarily the right to sell, but rather the responsibilityof handing a stronger company over to the next generation.Of the family-owned businesses in the study, two had gone through seriouscrises in the past few years—one the result of business problems, the other
102 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 3 N UM B E R 4 of difficulties in the interaction between the family and management. In both cases, the basic ownership structure made it unattractive to sell, so the family had an incentive to work problems out—and actually did so—rather than give up. Had these been public companies, their performance might have suffered much more and their ownership could have changed. Because exit is restricted and dividends are comparatively low, some family- owned businesses have resorted to “generational liquidity events” to satisfy the family’s need for cash. These events may take the form of sales of pub- licly traded businesses in the holding or sales of family shares to employ-One of the attractions stressed by ees or to the company itself, withmany interviewees is that family- the proceeds going to the family.owned businesses contribute to a One chairman said of his company,more meaningful way of life “Every generation has a major liquidity event, and then we can go on with the business.” Liquidity events can be staged; for instance, members of the family might have the right to sell their shares every ﬁve years at a price calculated by preestab- lished rules, but the total volume might be limited and the payments staged over a couple of years to avoid straining the company’s ﬁnances. Moreover, the families that own some of the companies don’t derive much economic beneﬁt and accept this because they have been educated to do so. As generations come and go, every old family business faces the challenge of making continued ownership attractive to an ever-larger family of which only a few members play any role in management. One of the attractions stressed by many interviewees is that family-owned businesses contribute to a more meaningful way of life. This lifestyle often centers on separate family institutions: a family council might be responsible to a larger family assem- bly, which may be used to vent family disputes and to build consensus on major issues.1 The council might also oversee a family office, ﬁnanced by the business, that assists family members who want to pursue common interests, such as social work, often through large charity organizations linked to the family office. Charity is a way to promote family values, to provide mean- ingful employment for family members not active in the business, and to involve young ones in real decision making; a group of 14- to 18-year-olds, for example, was granted an annual budget of $100,000 to distribute to charity. As one head of a family holding said, this kind of activity “brings the group together”; family members “analyze issues and work together to form a strategy. They learn a lot about responsible decision making and about following through.” 1 See Luis F. Andrade, Jose M. Barra, and Heinz-Peter Elstrodt, “All in the familia,” The McKinsey Quarterly, 2001 Number 4 special edition: Emerging markets, pp. 81–9 (www.mckinseyquarterly.com /links/7427).