Seven ways family firms can avoid failure

Family-run organisations make up two-thirds of all businesses around the world.

They account for 70%-90% of global GDP every year[1]. Yet despite their economic weight, their failure rate is high. In Brazil, only 30% of family businesses survive the transition from first to second generation, while only a tiny proportion (5%), reach a third generation[2]. The picture is similar in Mexico, where only 10% of family-owned companies make it to a third generation.

Mario Rizo, Partner at Grant Thornton Mexico, is familiar with the challenges faced by family firms. “Family business consulting is like going to the doctors,” he says. “We can only help you if you are honest about your symptoms. We will run tests and we might have to ask some sensitive questions but, ultimately, we will prescribe the right medicine.”

Here are seven health tips that draw on Grant Thornton’s extensive experience of working with family owned firms in Latin American to ensure family firms everywhere can survive into future generations.

1 Have a clear structure and policies

A lack of formal structures and procedures is a common weakness among family-owned firms. All too often, the lines between family, company ownership and the management of the business are blurred.

Rizo says: “A recurring mistake is to confuse ownership and management. Often, the same person wears three hats – the CEO is also the chairman of the board of directors, as well as being the main shareholder. All to often, this culture is then passed on to the next generation.”

The introduction of a written family constitution that states clearly the values and vision of the family, and regulates the relationship between family members and the business, can offset potential conflicts and help with succession planning.

2 Introduce strong corporate governance

Good governance is key to the long-term sustainability of any business. The creation of a board of directors and a family board is crucial to ensure business longevity.

“What we often see in Mexico,” explains Rizo, “is that family firms have corporate governance policies in place, but when the leader or founder steps down or dies, the next generation does not respect the company’s rules. A family board can help in these situations, as it regulates the relationship between family and business, acting as a bridge between the two.”

Firms should also consider the introduction of a shareholder’s agreement to regulate the manner in which shareholders can exercise their rights, he says. Additionally, the appointment of an advisory board, or independent board members, can bring fresh perspectives. Effective oversight can also avoid issues such as ‘sticky baton’ syndrome – where the older generation hands over management in theory but still attempts to retain control over big decisions.

3 Effective communication is key

Poor communication can often turn minor disagreements into major conflicts. Strong communication policies can help to take the sting out of emotionally charged conversations, which can range from managing the emotions of an outgoing CEO to involving shareholders in discussions. Ideally, there should be candid performance reviews and honesty when speaking with third-party advisors (see point seven) and other stakeholders.

“Many of the problems arising during conversations with clients are related to poor communication. There are instances where family members have very little knowledge about the company, even lacking a basic understanding of what the business does or whether it’s profitable, which can lead to decisions being made based on rumours or assumptions,” says Rizo.

4 Robust financial planning is essential

Another common pitfall is a lack of discipline when using business money for personal expenses. Also, remuneration policies that tend to reward family links ahead of ability or performance can have an adverse effect on employee motivation and staff retention.

Luciano Bordon, Partner at Grant Thornton Brazil, says there is often a perception that the company’s money and the owner’s money are the same thing. “It is very important to keep them separate,” he says. “Also, if a family member works in the company, he or she needs to be paid in line with other non-family employees in similar positions. There should be clear policies regarding remuneration, defined within the family constitution.”

Robust financial controls also need an emphasis on budget planning and monitoring, risk control and cost management. As Bordon notes: “Many family firms are very focused on sales and they don’t pay enough attention to the costs associated with running the business.”

5 The need for a strategic vision and planning

Not surprisingly, a lack of strategic planning can limit the lifespan of any business. Advice for companies is often to plan for ‘when, not if’, to avoid being caught out by unexpected events. Family-owned companies can also be more concerned about how well the business is performing today and be reluctant to step outside their ‘comfort zone’.

“It’s always helpful to try and visualise different growth scenarios, whether it is organic or through acquisitions or partnerships,” says Rizo. “Small and medium-size companies often don’t pay enough attention to planning – the owners might have a vision in their head but they should put it on paper, defining what they want to achieve and how they are going to get there.”

6 Don’t ignore talent management

Choosing the right person to lead the company into the future is perhaps the most important decision that family businesses take during their life cycle. Entrepreneurial talent within the family should be identified and nurtured from an early age. Likewise, it is important to avoid forcing children to join the firm if they don’t want to.

According to Bordon, succession planning must be done in conjunction with the implementation of a robust corporate governance framework. Having strong governance policies in place, including the support of external independent advisors and committees overseeing areas such as HR and finance, can help to overcome many of the potential sticking points during any discussions regarding future leadership.

“A detailed profile for the role of CEO should be part of the family constitution, specifying whether the position is open to non-family members,” says Bordon. “We often interview family members to assess whether they have the right profile and skills for the role. In some cases, we need to go back to the owners to say that their son or daughter might not be suitable for the top job and suggest another position that better matches their skills.”

7 External advice can secure success

There are often sensitive issues within family firms that can lead to conflicts and disagreements. Advice from an independent third party can help in this regard, facilitating more open discussions on emotionally charged topics, such as succession or differing views about the direction of the business. 

Other issues, such as regulatory compliance, corporate governance and financial planning, increasingly require the use of external expertise. Bordon notes: “In Brazil, family firms are worried about corporate governance issues and compliance requirements. More and more they are seeking help from external consultants to make sure they are doing things correctly.”

Conclusion: Family firms can be successful over the long-term

The overall goal for family firms is the smooth running of the company and extending its life into second and third generations, and beyond. To achieve this, it’s essential to have formal procedures in place, a long-term view and be risk aware.

As Rizo says: “Over the past decade, we have seen some of the most representative family businesses in Mexico seeking external advice to implement structures and policies to run their businesses in a more institutional manner. We still have a long way to go but we are moving in the right direction.”

If you would like to know more about tackling the challenges that face family firms, contact Mario Rizo or Luciano Bordon.