The governance gene tormenting family businesses

Family businesses employ half of the Australian workforce and can be paragons of productivity and workplace happiness. But governance remains an Achilles heel.

The soap opera of Gina Rinehart’s legal battles with her children is emblematic of the challenges now facing Australia’s family businesses. The Rinehart saga captures a story that comes up time and time again in many a family business: retirement plans on permanent hold, succession planning setting off purgative battle scenes and governance that leaves you feeling you’ve just been knifed. As Tolstoy reminded us in that first line of Anna Karenina, every unhappy family is unhappy in its own way.

It’s a problem ignored by business schools, management books and the mainstream media. Their focus is on listed companies yet two out of every three businesses in Australia are owned and run by families. Go figure!

Indeed, just about all of us have worked for a family business at some stage of our lives. Family businesses employ at least half the Australian workforce.

And for all the focus on listed entities, it’s worth remembering that some of the largest companies in the world are run and owned by family members. Publicly traded family businesses include Berkshire Hathaway, Wal-Mart and News Corporation.

They are carrying on a tradition going back to the Rothschilds, the dynasty founded by a coin dealer from Frankfurt who sent his sons throughout Europe to establish banks. Until the Second World War, only Rothschild family members could become partners in the business.

Family businesses are a unique management proposition. According to a famous 2003 study by Ronald Anderson and David Reeb, family owned businesses outperformed non-family businesses including listed companies. There are good reasons why blood is thicker than conventional competitive advantage. First, there are no restive investors to appease. Family businesses also have closer relationships to their suppliers and customers. Talk to the chief executive of most listed companies about their suppliers, ask them who their customers are, and they’ll refer the question to one of their departments. Talk to the chief executive of a family business and he’ll rattle them off from the top of his head. Family businesses also respond faster. And most importantly, they tend to maintain longer investment horizons than other shareholders. Finally, the family’s welfare is closely tied to firm performance. That gives them a strong incentive to monitor professional non-family managers. Free riders tend to last about 10 minutes in family businesses.

Still, all the data suggests family businesses have profound issues of governance and succession. It helps explain why some studies have found that only 11 per cent make it through to the third generation. And for those that get through to the fourth generation, it can be a completely different business from how it started out. Four generations in, there might be so many family members that ownership could be splintered. In these cases, they would be looking to diversify rather than keep everything in the family basket. In these situations, it would be a less a matter of 'ownership' and more about 'investment'.

The tripwire for many family businesses is succession. According to the latest PricewaterhouseCoopers survey of family businesses, only two out of five family business leaders plan to pass the business on to the next generation. A KPMG/Family Business Australia survey from 2009 found that about 72 per cent of family businesses had no plans to pass the business on to the next generation. While the study is now being updated, there is no evidence to suggest this has changed over the last four years. The MGI Australian Family Business Survey of 5000 Australian businesses conducted in 2010, in conjunction with RMIT University, found that succession planning is now a major concern for 20 per cent of family businesses, up from 9 per cent in 2006. The MGI survey has just been updated and the latest version is still to be released.

A 2011 KPMG/Family Business Australia survey revealed that only a handful of family businesses had formal mechanisms in place to deal with the most common conflicts – like, for example, future strategy (19.5 per cent), competence of family members working in the business (14 per cent) and succession (10 per cent). Of course, these sorts of conflicts are resolved but that only happens when the most senior family members intervene. That is the way families tend to operate.

Governance is another issue. According to the Family Business Australia study, four out of five didn’t even have something as basic as a family constitution, two out of three had not yet formalised a chief executive succession plan and three-quarters had no succession plan for other managers. More than half had no board or governing body, formal or otherwise. Two-thirds didn’t even have a family council and failed to provide family members with feedback as to how the business is travelling.

True, family businesses shouldn’t have the governance structures of larger companies – more than half of those surveyed had fewer than 20 employees. But a board of outside directors would heighten accountability in any size company and provide extra perspectives for corporate decision making.

It will be interesting to see what happens when coming generations take over, if indeed they do. While only 4 per cent of those surveyed thought governance was an issue for the next generation, the study found that the next generation saw this as a problem, with 23 per cent saying they intended to tackle governance as a priority when they take over. Given there are so few succession plans, you would have to ask whether they’ll ever get there.

All this explains why sixth or seventh generation family businesses, like Levi Strauss, are the exception. Levi Strauss is an example of how a good family business is run. While shares in the company are privately held by descendants of Levi Strauss, the company’s managers are all outsiders, non-family professionals who can be objective. In the best family companies, the top jobs are given to non-family members. Still, that’s no guarantee. The management at Darrell Lea were all non-family when the company went bust. 

While few family companies survive beyond the third generation, they are critical for this economy and, despite their governance and succession issues, they’re unlikely to disappear while the dynamics are shifting away from large corporations to medium sized companies.

The challenge for family businesses is retaining control, keeping that competitive advantage and dealing with governance issues as a priority. For family business leaders, it’s not about them as individual managers, it’s about the business. As noted management thinker Peter Drucker says, the family business that lasts is the one where the family serves the business – and not the other way around.

For more family business commentary and news click here.