Dealing with family businesses

Despite the importance of family businesses across the globe it is surprising that often their business partners do not know how to deal with them. Business partners —  whether investors, private equity firms or joint venture partners — tend to focus on the business side of the family business. However, every family businesses combines two conflicting sides. On one side there is the business where profit, growth and shareholder returns are paramount. On the other side there is the family where emotions of love, fairness and trust reign supreme. Successful family businesses skillfully navigate these disparate perspectives to achieve both success and stability in their business. If a family business fails because it cannot reconcile the needs of the business with the wants of the family, its partners (who have invested time, capital and other resources) also lose a great deal. So one would expect that potential partners are alert to this conundrum when they begin engaging with family businesses. Yet this is often not the case. Partners often treat family-owned businesses as they would any other company, which is a mistake. We believe potential partners should undertake a more comprehensive evaluation of the family before working with them. 

In particular, there are five areas worthy of deep investigation.  

n The reputation of the family: It is important to understand the family’s reputation. This can be done by examining their past behaviour or the behaviour of other companies owned by the promoter group. Have their joint ventures survived? Have promoter group companies defaulted on their loans? How have they used the judicial process? How close are they to certain political parties? It is crucial for potential partners to speak with other partners to understand their experience working with the family. 

With that said, it is also worth noting that family businesses with strong reputations cherish their reputations.  They will go to great lengths not to stain the integrity associated with their names. Only in truly extreme situations will they default on their commitments. Typically, their partners will trust them deeply because of the flawless reputation of the promoter family. 

n Identify the decision makers: In family businesses often the formal structure of the company does not reflect the underlying power dynamics of the company. While there may be a CEO or chairman of the company, their actual autonomy might be limited. Their titles are often titular. So it is critical to identify the true decision maker. This may be a head of the family (such as a patriarch) or a group of elders that deeply influence business decisions despite holding no official titles. Potential partners must know them, understand their individual motivations and their vision for the family business and ensure these are in line with their own objectives before entering into a partnership. 

If partners find that there is a lack of alignment between different members of the family then they should be careful and recognise that decisions taken by the current incumbent may be stalled or even overturned later. Ignoring the underlying family dynamics is a big mistake which can turn out to be very time consuming and costly for potential partners. 

n Understand the influence of non-family top executives: The power that non-family executives have in a family business varies. Some long-term executives serving in a company may actually be very influential.  Their advice is taken seriously and they know how to navigate the family’s dynamics. So their support counts for a lot more than that of a freshly installed CEO. In comparison many freshly hired CEOs may not last long in the company especially if they come to the family business from a different background (like an MNC) — simply because they will not understand the culture of the family and the company. Potential partners must differentiate between these different types of non-family executives in family businesses.

n Understand the succession dynamics: Succession in family business is complicated. If there is a clear line with one uncontested inheritor, and the relationship between the successor and the parent is good then there isn’t much to worry about. But if there are more than one aspirant it becomes critical to understand the succession plan of the family (especially if the current leadership is nearing retirement). And if no plan is in place then potential partners must be concerned. Family businesses may be split between successors or given to one sibling rather than the other. Succession battles in family-owned companies are often bitter and public that almost always cause massive value erosion. No potential investor or lender would ever want to be caught in the middle of such a battle. 

n Underlying nature of capital markets: Finally, potential partners must assess the financial ecosystem within which the family business operates. The ease with which partners can exit a family business will differ greatly across countries and this has implications on the safety of their investments. It would, for example, be much harder for a private equity investor to sell a stake in a family business in an emerging economy without developed institutions. In the same vein, developed markets also allow family businesses more freedom to find alternative sources from where they can raise capital or manage family restructuring. All partners need to appreciate this. 

Given the critical position of family businesses in many economies, it is surprising that more work has not been done in helping partners create a work book on how to deal with them. Though there are many partners who have a good intuitive understanding of how to do business with family businesses — there are many that do not and flounder because their due diligence ignored the family dynamics of the promoter group. Business partners should take care to understand the family in a family business or they may find family businesses too enigmatic to deal with.

Sinha is chairman & Govindaraj is consultant, BCG India. Views personal