Value Creation in a Family Business

Overview

Value creation is a challenge in any setting, but for those seeking to navigate a path to maximal value creation in a family business, the need for a nuanced, holistic understanding of the strengths and weaknesses of these organizations, and why these characteristics persist over time, is essential.

Family businesses have an outsized role in the U.S. economy, and yet they remain poorly understood by current and prospective stakeholders including advisors, capital providers, employees, professional managers, supply partners, and others. The root cause of this misunderstanding is the fact that for those who find themselves working with a family business, the experience presents a dizzying array of contradictions. A family business will often seem to have a preternatural ability to execute on the “hard” problems of managing a business. Frustratingly, this characteristic strength is typically offset by a stunning tendency to fall short on the “easy” issues of governance, strategy, succession planning and talent management, among other areas.

Successful value creation in a family business context, therefore, requires change agents to identify levers that will allow them to emphasize the strengths that these companies often possess while working to minimize the challenges with which many of them struggle.

Attributes of Success

McKinsey has identified five key attributes correlated with long-term family business success. These attributes, when carefully tended to, have been shown to be sources of considerable competitive advantage and drivers of long-term value creation. Understanding and marshalling these attributes offers a way forward in any planned business transformation. However, failure to address each of these attributes in a disciplined manner can lead to organizational chaos, strategic confusion, and a painful cycle of value destruction.

The five attributes are:

Family. Ensuring the capture and dissemination of key informational aspects of a business is something that many leaders agonize over. Remarkably, family businesses often seem almost custom built to excel on this very issue, with many possessing a deep reservoir of business-critical knowledge spread across multiple employees (often not all family members).
Ownership. Engaged ownership comfortable with their company’s leadership and enthusiastic about future opportunities can serve as a stabilizing influence in charting a strategic course for long-term value creation, neither overreacting to periods of market exuberance nor panicking during periods of market stress.
Governance. Having a structure in place to ensure that the family has a mechanism for involvement in the business, particularly for those family members whose stage of life might suggest something less than full-time involvement, is critical.
Wealth management. When family businesses take the time to address family member wealth management and planning needs upfront, they eliminate a potential source of stress. A clear set of expectations regarding family member wealth management needs, whether a scheduled capital return policy or a focus on generational liquidity events, can free up the time and attention of the family and leadership team of a family business to focus on execution of the strategy and fostering long-term value creation.
Foundations. Not every family member will be interested in or well suited to an active roll in the family business, especially in later generations. The creation and support of family philanthropic efforts, many times in the form of a family foundation, can offer family members an alternative means of involvement that might be more in line with their interests.

Strengths of a Family Business

Outsiders underestimate the strengths of the family business model at their peril. There are structural advantages that these firms wield which combine to allow family businesses to thrive on a level of trust and a web of informal communication that should rightly be the envy of any company operating under a different structure. Family businesses are adept at managing for the long-term, maintaining and utilizing both formal and informal communication channels to foster decision making, and maintaining a coherent sense of corporate identity across generations.

For leaders seeking to chart a strategic course, change agents seeking to catalyze a business transformation, capital providers seeking value accretive partnership opportunities, and all other current and prospective stakeholders, understanding and fully exploiting these strengths is critical.

Long-term focus. Charlie Munger, co-chair of Berkshire Hathaway and long-time partner of famed investor Warren Buffet offers sage advice on the power of compounding: “the big money is not in the buying or selling, but in the waiting”. The family business model, with its inherent multi-generation outlook, is particularly well-suited to this approach, and as a result, family businesses can reap the incredible value creation rewards bestowed on investors willing and able to allow a compounding investment to continue compounding.

Clarity of purpose. Family businesses often exhibit a profound clarity of purpose, passed on in many cases from generation to generation. As a result, leaders of a family business often feel empowered chart a more conservative approach to value creation, featuring lower levels of leverage than their comparably sized peers. Family businesses may often not seize full advantage of growth opportunities, but they are also less inclined to value destructive transactions, with the result that many family businesses have demonstrated a structural ability to outperform businesses operating without family involvement.

Leading a business transformation requires identifying and catalyzing a virtuous cycle in a business. For a family business, the rough outline of a value accretive virtuous cycle would be as follows:

Long-term focus > Clarity of purpose > Compounding strategies > Conservative capital structures > Increased versatility > Fewer but higher ROI investments

Weaknesses of a Family Business

The weaknesses of a family business are in many respects the mirror image of their strengths, with patience, clarity and a disciplined approach giving way to complacency, risk aversion, and resistance to change.

Complacency. The extreme value creation potential of uninterrupted compounding turns from a blessing to a curse when the sign changes. Too often, family businesses are slow to acknowledge negative trends and act decisively to address them, leading to an unnecessarily severe level of value destruction before corrective action is taken.

Risk Aversion. When the traditional conservative bent of a family business shifts to risk aversion, promising opportunities are disregarded, and de facto risk appetite can fall to zero, leading companies to unnecessarily cede opportunities to their competitors.

Transformational leaders should be on the lookout for signs of the typical value destructive vicious cycle for a family business:

Complacency > Inward focus > Risk aversion > Resistance to change

Conclusion

A necessary condition of successful value creation in a family business is an understanding of the unique strengths and weaknesses of this ownership structure and a sense of how these strengths can be leveraged and weaknesses mitigated in support of the goal of maximal value creation. When this condition is met, the stage is set for a compelling long-term value creation opportunity, to the benefit of the family and other key stakeholders of the business.

About the Author

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition. Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. David is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation. He can be contacted at: david@abraxasgp.com.