The best course

July 24, 2018

Research findings show that large, longstanding, publicly traded family businesses grow faster than non-family ones.2 They are more resilient, and outperform market returns by several percentage points. Across the economic cycle, average long-term performance was higher for family business than non-family business. Family businesses performed better during recessions, and less well during good economic times. Overall, they carry less debt and invest less in capital expenditure, R&D, and acquisitions. Research also shows that CEO tenure in family businesses is several years longer. Hence, outperformance is accompanied by a number of quite specific traits, which may provide valuable lessons for others. Why are these traits beneficial and what can be learnt from them?

Family-owned businesses form a critical part of any economy. They account for 80% of companies worldwide and constitute the largest source of employment in most countries.3 In the US, they employ 60% of workers and whilst many are small they also make up one-third of S&P companies.4 In East Asia and Latin America, they constitute around 60% of firms and in Germany and France, they are around 40% of the largest firms. Whilst they make up the predominant form of business, their approach does contrast with the more conventional listed business and indeed those with financial owners. There is plenty for all to learn from successful family businesses. In recent years, there has been more research in this previously neglected area, which helps identify what successful family business does well.

alignment of shareholder and management interests

First of all, family businesses are normally run by the owners; so, shareholders and management are tightly aligned on objectives. In a public-listed business, this is a perpetual problem as boards frequently run the business for their own interests rather than those of the shareholders. This is often demonstrated through CEOs giving themselves large salary packages with little relationship to performance. High-risk mega mergers are embarked upon, which often have little chance of creating shareholder value. Similarly, firms often engage in unrelated diversification which has a low chance of success. This is frequently to diversify the business, which reduces risk for the management. However, shareholders would much rather have the cash, so they can diversify their own portfolio as they please without management doing it for them.

agency problem

This divergence of interests is termed agency problem, and much of corporate governance practice and legislation is intended to find ways of aligning interests. However, it is arguable to what degree it is successful. In many ways, the private equity industry and activist shareholders have been successful because of the failures of corporate governance in listed business, and the disregarding of shareholder interests. Private equity aligns the management with shareholder interests by giving them between 15% and 30% of the equity. Activist shareholders effectively bully the chairperson and CEO into favoring shareholder wishes through media campaigns, shareholder letters, difficult EGMs, and attempting to rally support from other shareholders to fire them.

planning and investment horizons

Family businesses usually have long-term objectives to offer gainful and interesting employment to the family and their progeny. As a consequence, they plan over longer time horizons to deliver strategic success. A German family-owned business, for which I was a board member, invested a substantial sum in a new plant with a ten-year payback. UK- and US-listed businesses are normally driven by shareholders into much shorter time horizons of announcements and even private equity are planning over three to five years before sale.

Family businesses are careful with resources as they are keen to maintain control and avoid high levels of leverage common in private equity or offering new shares, which dilutes both ownership and their control. This tight ownership of shares means boards can make rapid decisions, and are not bogged down with corporate governance matters as is common with listed business. As a consequence, not only do they treat the money as their own but also avoid high levels of risk.

significant investments

R&D investment, for example, is often wasteful and for every successful project there may be several, which are not. Now more major corporates are outsourcing R&D on contracts and buying up smaller firms which have successfully innovated. In effect, large companies are often poor at innovating and can squander large sums of money in this area. Similarly, capital expenditure programs have a high failure rate with around 20% producing no discernible returns and around 70% failing to deliver expected benefits, overspending, or being late. Some of this high failure rate can be attributed to the process for approving capital expenditure. The competition between projects, for limited internal funds, incentivizes the management to propose rather optimistic cost levels, time scales, and scope. The management may assume the project will go precisely to plan which rarely arises.

M&A is another area in which much resources are wasted with a 25 to 30% overall success level and around 60% actually destroying value. About half are sold off within five years. Research suggests that smaller bolt-on deals often add value whilst bigger deals rarely enhance shareholder value. Bigger acquisitions usually cost disproportionately more and are much more complex to integrate. These are all pitfalls, which family business is better at negotiating than a listed one. In many ways, a listed business can generate significant sums of cash but rather than return it to the shareholders the board engages in various risky investments which often have a low chance of success, and are likely to destroy shareholder value.

private interests and the business

However, a family business is not without its problems. Families struggle to distinguish between business and other activities. So, family dinners are often business discussions which exclude non-family members. As a consequence, non-family may not be consulted and may consider themselves ‘second class citizens’. There is frequently a lack of trust of senior non-family management bordering on paranoia, and a view that senior management are trying to steal the company. This exclusion and distrust mean that attracting and retaining high-quality staff can be difficult.

Sometimes a family need for money can drive strategy, such as when divorce occurs, and ownership of the business then becomes fragmented. The business may have to find cash to settle divorce bills. The financial needs of family members can drive the distribution policy rather than the needs of the business. Growth opportunities can be missed and failure to grow compared to rivals can result in decreasing relative scale and scope economies. Market power and presence can similarly be restricted through family private needs.

succession planning

Succession planning in many businesses is often given lip service as the chairperson and CEO do not like planning themselves out of a job. Indeed, once a clear succession plan is created, the obvious question becomes why not sooner rather than later. Contrast this with the long-term plan for careful development of a chosen family successor. It is seen as in all family members’ best interests to pick the right person and to contribute to their experience so that the family business can continue to prosper. The problem arises when an appropriate interested family member cannot be found. In such a scenario, the disposal of the business or engagement with an outsider has to be considered. Indeed, the statistics for survival through the generations with only around 3% making it to the fourth generation are based on the constant issue of identifying an appropriate successor from within the family. The generational change is critical and selection of the wrong family member may have dire consequences. Disposal of the business usually follows being unable to identify an appropriate successor from within the family.


There are clear lessons for all from the success of family businesses. Firstly, be careful with investments and do not fall into the traps of destroying value through extensive investment without a high hurdle level and careful sensitivity analysis. The private equity approach that subsequent investments should create similar returns to the original investment has much to be commended. Careful and restricted investment through periods of economic growth can be balanced by a greater ability to exploit opportunities during recessions when competitors have their hands tied through high-legacy borrowing levels. Identification and careful development of a successor to the leader result in a much longer tenure, and far less chopping and revision of strategy with changing leaders. In turn, this results in much longer-term strategy planning and implementation.


01 a complex tapestry by John A Davis, The Smart Manager, Jul-Aug 2014