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Family Business Definition and Characteristics – Strengths and Weaknesses

Provided by IFC Corporate Governance

Definition: In this Handbook, a family business refers to a company where the voting majority is in the hands of the controlling family; including the founder(s) who intend to pass the business on to their descendants. The terms “family business”, “family firm”, “family company”, “family-owned business”, “family-owned company”, and “family-controlled company” will be used interchangeably throughout the Handbook to refer to family businesses.

Strengths: Several studies have shown that family-owned companies outperform their non-family counterparts in terms of sales, profits, and other growth measures.[1] A Thomson Financial study for Newsweek compared family firms to rivals on the six major indexes in Europe and showed that family companies outperformed their rivals on all of these indexes, from London's FTSE to Madrid's IBEX. Thomson Financial created a unique index for both family and non-family firms in each country, and tracked them over 10 years through December 2003. In Germany, the family index climbed 206 percent, while the non-family stocks increased just 47 percent. In France, the family index surged 203 percent, while its counterpart rose only 76 percent. Family businesses also outperformed their counterparts in Switzerland, Spain, Britain and Italy.[2]

This high performance is the result of the inherent strengths that family businesses have compared to their counterparts. Some of these strengths include:[3]

- Commitment. The family –as the business owner– shows the highest dedication in seeing its business grow, prosper, and get passed on to the next generations. As a result, many family members identify with the company and are usually willing to work harder and reinvest part of their profits into the business to allow it to grow in the long term. In dealing with its family business clients, IFC highly values having a committed set of shareholders at the core of the company.

- Knowledge Continuity. Families in business make it a priority to pass their accumulated knowledge, experience, and skills to the next generations. Many family members get immersed into their family business from a very young age. This increases their level of commitment and provides them with the necessary tools to run their family business.

- Reliability and Pride. Because family businesses have their name and reputation associated with their products and/or services, they strive to increase the quality of their output and to maintain a good relationship with their partners (customers, suppliers, employees, community, etc.).

Weaknesses: Perhaps the most often cited characteristic of family businesses is that many of them fail to be sustainable in the long term. Indeed about two-thirds to three-quarters of family businesses either collapse or are sold by the founder(s) during their own tenure. Only 5 to 15 percent continue into the third generation in the hands of the descendents of the founder(s).[4]

This high rate of failure among family businesses is attributed to a multitude of reasons. Some of these reasons are the same ones that could make any other business fail such as poor management, insufficient cash to fund growth, inadequate control of costs, industry and other macro conditions. However, family businesses also show some weaknesses that are especially relevant to their nature. Some of these weaknesses are:

- Complexity. Family businesses are usually more complex in terms of governance than their counterparts due to the addition of a new variable: the family. Adding the family emotions and issues to the business increases the complexity of issues that these businesses have to deal with. Unlike in other types of businesses, family members play different roles within their business, which can sometimes lead to a non-alignment of incentives among all family members. This point will be discussed in more detail in Section I of the Handbook.

- Informality. Because most families run their businesses themselves (at least during the first and second generations), there is usually very little interest in setting clearly articulated business practices and procedures. As the family and its business grow larger, this situation can lead to many inefficiencies and internal conflicts that could threaten the continuity of the business.

- Lack of Discipline. Many family businesses do not pay sufficient attention to key strategic areas such as: CEO and other key management positions’ succession planning, family member employment in the company, and attracting and retaining skilled outside managers. Delaying or ignoring such important strategic decisions could lead to business failure in any family business.

[1] Denis Leach and John Leahy, “Ownership Structures, Control and the Performance of Large British Companies”, Economic Journal, 1991.

[2] Newsweek, www.msnbc.msn.com/id/4660477/site/newsweek.

[3] Sir Adrian Cadbury, Family Firms and Their Governance: Creating Tomorrow’s Company from Today’s (Egon Zehnder International, 2000); John Ward, “The Family Business Advantage: Unconventional Strategy”, Families in Business, 2002.

[4] Fred Neubauer and Alden G.Lank, The Family Business: its Governance for Sustainability (Routledge New York, 1998).

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