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Family Business Exam 1
Terms in this set (55)
How do Family Businesses effect the economy today?
-Constitutes 70% of all incorporated businesses in the U.S
-Generate 49% of the GDP in the U.S.
-Employ 80% of the U.S. workforce
-Create about 85% of all new jobs in the U.S.
-35% of S&P 500 firms are family controlled and those companies outperformed their management-controlled counterparts
-Family-controlled firms had a 6.65% greater return on assets (in EBITDA terms 1992-2001)
-Family firms created additional 10% market value (1992-1999)
What problems arise in starting a Family Business?
· Approximately 85% of entrepreneurial all new businesses fail within the first five years
· Among those that survive, only 30% are successfully transferred to the second generation of the founding-family owners
· Only 12% survive under current ownership to the third generation ...and only 4% to the fourth generation
What can be done to ensure survival of a Family Business?
Succession Planning is critical
To survive as a Family Business you must have:
1. Vision that is shared
2. Leadership that crosses generations
3. Successful Family, Management & Governance practices
Most Family Businesses fail to continue as such due to a failure in succession planning
* (passing from one generation to next)
How do you perform Succession Planning?
Succession Planning Requires:
- Dialogue across generations of owner-managers
-The tension between preserving and protecting the core of what made the business successful
-Promoting growth and adapting to changing competitive dynamics
What makes a Family Business Different?
· Nepotism (favoritism) (negative)
· Family/owner/manager vs. just a manager (+/-)
· Non-economic family goals and values (+/-)
· Long-term approach or outlook (+/-...generally more +)
· Family emotional commitment/ Stewardship (+)
· A lot of Personal time/effort/money (+/-)
· Altruistic (selflessness) (+)
· Quality if better, protecting family name/reputation (+)
How did our class define a Family business?
· Involves 2 or more members of a family that controls the majority of the ownership of the business
· The business honors/influenced by family's values
· One of the goals of the business is to provide financial support for the family
· There is the possibility of ownership being passed down from one generation to another
Who are the influencers of a family business?
- top management
- active family members who have ownership
- founder (if still in 1st generation)
- board members
- the next generation
- agency (outside)- outside trusted advisors
- spouses/any family member even if they don't work in business
What must you do to establish credibility in a Family Business?
- Gain Respect
- Previous experience
- Work your way up
- Know how to show weakness
- Work harder, don't slack
- Don't take advantage of the family perks, earn privileges
- Innovative ideas
- Managing non/and family relationships within the business
Benefits of working in a Family Business?
-Continue the legacy
-Still be apart of their child's life
-Job security for children
- Knowledge of the business already
- Cheap labor
- Job security
- Ability to move up the chain quickly
- Good pay and fringe benefits
Disadvantages of working in a Family Business?
-Child Wont work as hard
-Defy their authority
-Unrealistic expectations of the child (pay, positions, benefits)
-Family business overlap all the time (dinners turn into business meetings)
-Be controlled by parents
-Couldn't leave for a different job opportunity (loyalty)
-Held to higher expectations
-Wont take you are seriously (credibility)
-Being sucked up to by non-family employees
-We don't want to be looked at as "bosses son"
What are the causes of ineffective succession in a Family Business?
1. Conservative: Legacy generation doesn't want to give it up
2. Rebellious: next generation does take over, too many changes, clean sweep of the older generations plan/values
3. Wavering: next generation does take over, but waver on where to take company, keep same values or change it, or in between
What are the four theories of Family Business?
1. Systems Theory
2. Agency Theory
3. Resource-based Theory
4. Stewardship Theory
What is the Systems Theory?
- The firm is a dynamic system in which integration is achieved by adjustments between family, management, and ownership subsystems
- Individual perspectives of family and firm may differ, leading to overemphasis on one sub-system at the expense of others
What are the subsystems of the Systems Theory?
· Often by default, the family is often overemphasized
· All decisions made through viewpoint to benefit the family, financial direction towards benefit of family
· Transparency would be secretive inside family only
· Perks geared to be strong for family
· Return on investment
· Focus on money, regardless of how it is done
· Best person for the job, regardless of family ties
· Not necessarily focused on passing it down generations
What is Agency Theory?
- Agency costs are internal costs incurred by a firm to have someone act on its behalf
-Differences in the objectives of shareholders and the objectives of CEO/Managers (agents) can make those costs devastating
What do shareholders want?
What do CEOs want?
-Job security, highest pay, least amount of effort, worried about me!
-Compensation plan to make money for shareholders, then CEO makes money (win:win)
-Agency cost to get CEO to act they way we want him to
Shareholders don't directly supervise the actions of their agents and thus put governance in place (monetary and moral) to insure these agents optimize results in their behalf
-Owner and manager (family member regardless) lower agency cost is they are the same person or aligned
-No need for extra incentives. Automatically aligned. Inherent advantage.
-Could go wrong...the management could be abused/nepotism towards family members even though an employee (family member) isn't doing well and hurting company growth/profits
What are the positives and negatives on Agency Theory?
-The natural alignment of owners as managers decreases agency costs of ownership in family firms (not having to give extra incentive to manager to do right thing)
-The altruism of owner/managers leads to increased agency costs
- Entrenched family leaders are reluctant to transfer power to others
The BAD outweighs the GOOD
How can you control Agency costs?
- Agency costs can be controlled through the use of certain managerial/governance practices
- The board of directors is important in monitoring managerial behavior and controlling agency costs
What is the Resource-based Theory?
Looks at unique capabilities that family firms convert into competitive advantages:
-Already know the business
-Learning-curve: shorter time
-Form trust of family members idea/decision
-How you run it differently, more unique than other companies
** Reputation- weight of family reputation can be
leveraged and more important to have competitive advantages
The ability of a family business to capitalize on its unique advantages depends on the quality of the interaction between business and family
The three key advantages of a Family Business according to Resource-based theory?
1.Efficiency -lower administrative costs due to owner/management overlap
2.Social Capital - transfer of knowledge and relationship building between generations
3.Opportunistic Investment - speed and agility to react to new opportunities
What is the Stewardship Theory?
This perspective claims that founding family members view the firm as an extension of themselves and therefore view the continuing health of the enterprise as connected with their own personal well-being
-Owners inherit a responsibility to others in the family and organization
-Next Generation owners must steward the enterprise they received from earlier generations and successfully pass it on to the next generation
-As stewards of the firm, family owners often place individuals on the board that can provide objective advice
-The independence of the board has a positive impact on the financial performance of the firm through its advisory role more than through its monitoring or supervisory function
-Firms with continued founding-family ownership and relatively few independent directors perform significantly worse than do non-family firms!
What are the key takeaways from these theories?
1. Joint optimization of Ownership, Management and Family subsystems
2. Controlling agency costs
3. Exploiting the unique resources available to a family business to achieve competitive advantage
What perception do family businesses have on ethics?
Sometimes viewed as less ethical:
-Only incentive is to protect family wealth
-Less transparent than public firms
Sometimes viewed as more ethical:
-Have incentive to uphold family name and reputation
-Family members care more than corporations
-Family businesses are no more likely to engage in positive social initiatives than non-family firms
-However, family businesses are less likely to engage in activities that have negative social consequences
-Image is everything! Definitely a perception that family businesses are more ethical- use as advantage!
How does the family culture play a role in the business?
1. Creating a unique competitive advantage for the business
2. Creating organizational challenges
Family members who do not participate in management still often have significant influence
In Reardon Supply in the text, why did the sister believe her brother Bob was over paid?
- Sister said "My husband is president of bigger company but somehow you are making more money" YET brothers company was more profitable and privately held
-She wasn't apart of business, but she influenced and caused issues for the family business
Give an example of two different family cultures from our reading?
The Binghams in Louisville:
-Sold their company after years of bickering
-Sale of company did not bring the family together!
- A commitment to family-business continuity
- A family "trust catalyst"- like the spouse of founder
- A board with independent outsiders
- Family meetings
The Blethens in Seattle:
- Continue to own and operate several newspapers into their fifth generation of ownership
- Goals: "To perpetuate Blethen family ownership and to maintain the dominance of the Seattle Times Newspaper"
- A commitment to continuity/ Stability (even in the face of a financially crippling strike)
- Emphasis on individual responsibility to the group
- Family unity
- Frequent family meetings
- Sense of stewardship theory! What their purpose is with this family and family business.. pass this on from generation to generation and be the voice of the community.
What are some of the top reasons that businesses fail?
1) Concept is poor
2) Capital is insufficient
3) Financial controls are weak
4) Lack of Planning - succession, risk management, estate planning
5) Management experience is deficient
6) Family dynamics- family issues ruin the business
What are Zero-Sum dynamics? Why are they important?
When one party's perceived gain is the other party's perceived loss (Win-Lose, not Win-Win)
- The absence of growth (and thus opportunity for increased wealth/career advancement) in the family business is fertile ground for zero-sum dynamics and family conflict
- This dynamic can be triggered by any perceived difference: male-female, active in management-inactive in the firm, older-younger, richer-poorer...
"Multigenerational family-controlled businesses... are largely illiquid enterprises."
-Most are privately held- there's no market for it to be liquidable. You will probably have to do it through bank loans.
What makes for an unhealthy family culture?
- Lack of information
- Little knowledge of the business among at least some family members
- Low levels of family emotional intelligence (EI)
- Self- awareness (aware)
- Self- management (control own emotions/ adapt)
- Social awareness (react to others)
- Relationship management (inspire/influence others, help manage conflict by managing others)
What are the results of an unhealthy family culture?
-A founding culture that supported autocratic leadership
-The family's belief in the benefits of privacy
What is emotional intelligence?
· Aims to improve the ability of individual family members to know their feelings in order to use them appropriately to make decisions
· Seeks to increase our ability to handle feelings with skill and harmony even in the face of differences between family members so better decisions can be made and teamwork/family unity can thrive
· Emotional competence inventories with 360-degree feedback can be helpful to next-generation members of a family in business
How can a good family culture benefit a business?
· A family business with a high level of family harmony tends to be more effective in planning for business continuity
· This positive family-business interaction factor was a great predictor of the number of best management/governance practices implemented
What tools/practices should be used to ensure the businesses health and harmony?
- Family mission statement or constitution
- Family Business governance structure
- Family member employment policy
- Family member personal development goals
- Family Business succession plan
- Personal estate plans
- Compensation plan and buy-sell agreement
What is the best way to implement these tools?
- Formal meetings that promote open education and communication to help prevent zero-sum dynamics
- Provide a reliable forum for delivering information about the state of the business, its financial performance, its strategy, and the competitive dynamics it faces
- Offers a safe haven in which to teach all family members about the various rights and responsibilities that accompany being a business owner and manager
What are the benefits of a family council?
-Family meetings can provide a forum for minimizing the potential for conflict and addressing problems that confront multigenerational families
-Family councils foster open and safe processes for sharing information
-The focus of family councils should be conversations, deliberations, and policy making
How should a family council be run?
Start with a family mission statement that defines what is best for the extended family and business
-Focus on the future and let go of the past
-Use outside facilitators who can be a sounding board and help keep the focus on the process
-Benchmark your drafts of policies against those of other successful family companies
Why is promoting the family important?
Family unity is a strong predictor of the successful use many of these best managerial and family practices:
-Establishing formal Family Councils
-Boards with independent outsiders
-Non-family in key managerial positions
-Succession plans in place
-Family unity helps the company translate core competencies into a unique set of competitive advantages
What makes 1st Generation firms successful?
2.Investment in training/personnel development
3.Investment in research and product development
What problems arise once 2nd and 3rd generations take over?
Increased likelihood that 2nd and 3rd generation owners won't be working directly in the company causes problems such as:
•Compensation, dividends and liquidity
•Return on investment
•Realistic assessment of business & its opportunities
•Business management strategy
What problems can arise from family shareholders?
Historical family dynamics can affect the "trust factor" of non-involved shareholders
-This can be exacerbated by a spouse's heightened sense of mistrust (sometimes heightened by a spouse)
-Management decisions may be misinterpreted
Why are investments in the ownership subsystem important?
If a family business is to preserve one of its intangible competitive advantage —its propensity to manage with a long-term horizon— investments in the ownership subsystem are essential
This means investing in:
1. Design and execution of an appropriate ownership and control structure
2. Education and access to information plus engagement of shareholders (particularly those family members not working in firm)
3. Creation of institutions that govern interactions between the ownership and firm management
What do shareholders want from a family business?
-Risk adjusted returns as captured in shareholder value, dividends or distributions
Family firms often want more than just a financial scorecard!
· Noneconomic outcomes such as:
What are the characteristics of an ownership system?
2) Unconditional acceptance
3) Minimizes change
4) Inward oriented
What are the characteristics of a management system?
2) Conditional acceptance
3) Requires change
4) Outward oriented
What are blurred boundaries in a family business?
· Boundaries among family, ownership, and management systems may become blurred...
-Problems determining if decisions relate to family, ownership, or management issues!
-Family priorities may overtake the business
-Family Business problem solving ability can be diminished by these blurred boundaries
How does a family business operating as a joint organization look?
· Balance the needs of each of the family, management, ownership subsystems
-Use family forums, family councils and family business governance boards
· Allow for some family members to be employees and others to be responsible shareholders
-Utilize the best aspects of each subsystem!
What are some important policies and priorities to have in a family business?
· Family members are encouraged to work outside the business to get experience
· Upon joining family business their development for leadership is a priority
· When family members meet, conversation is both family and business oriented
· Families members and the firm have a commitment to family business continuity
What are the benefits of having a governance board?
· Superior performance in shareholder value is aided by the composition of the board
· Research has found that higher-performing firms are those in which independent directors balance family board representation
-Independents and advisors are not meant to exclude continuing family participation on the board (bring in some kind of outside voice, not just family, addition ex: exec from other company, past experience guy in industry, professional advisor/consultant, lawyer)
· The role of the board is prominent in governance where the owner-family-management interaction is perceived as a positive-sum dynamic
How do you keep the governance board's goals parallel to the owners goals?
· Next-generation leaders frequently undertake a critical review and restructuring of the firm's board
· Communication and education beyond traditional board work and strategic planning processes are needed because of a family's legacy on the board
· The family's identity remains attached to the company's so if the company needs to change in order to adapt and grow then the board composition probably needs to change too!
How do you maintain a relationship with the companies shareholders?
· Shareholder meetings are a way to align non-concentrated ownership and management...
1. Opportunity to education
2. Allows for information sharing
3. Safeguards a healthy governance
What benefits do shareholders meetings have?
· Chance to align shareholder priorities with management interests and hold management accountable
-Shareholders need to be educated on understanding the financial statements
-Shareholders need to know competitive conditions
· Without knowledge family-business shareholders can become indifferent, impatient and could hamper effective operation of the business
What must family shareholders understand?
· They must understand a financial statement!
· As part of their financial literacy family shareholders should understand:
-The capital structure of the firm
-Debt levels in relation to owners' equity
-The firm's ability to operate independently or risk influence by banks/outside capital in how the business is operated
What are the responsibilities of a family shareholder?
· Define and then demand what are reasonable returns on shareholder equity or invested assets
-No resting on past accomplishments
-Hold managers accountable
· Put your stamp on it!
-Provide the values and principles of doing business and ensure they remain instilled in the company
· Define the owning family's strategy and communicate the owning family's priorities
-This is assuming you know what your family's strategy and mission is!
How can you ensure that a next-generation can lead how they want to?
· Think about next gen, whoever will lead it needs authority to lead by being given leading # of shares (equal shares don't help...one needs to have majority voting shares to have authority over the business)
· The authority to lead is earned, not inherited
· Transferring ownership without regard to corporate control makes it more difficult to acquire the authority to lead
-Recapitalize the stock into voting and nonvoting shares
How should stock be issued to non family members?
· Phantom stock can be created in order to provide the incentives for key nonfamily management to behave like owners
-Phantom stock mirrors the value of regular company stock but does not dilute the family's actual ownership and has no voting rights (fake stock)
What are the drawbacks of phantom stock?
- Liability- must pay them when they leave (do we have the cash to pay it down the road?)
- Non-family member manager is at risk
- Valuation disagreements- I think its worth x and you think its worth x.. need formula to keep up with value of a privately held company...very hard
- No market- who's going to buy your 500 shares when you want to sell it...it'll only be the owner that gave it out because there no real market value since its privately held
How do buy and sell agreements work in a family business?
· Contractual agreements between shareholders and the company
· Typically used to facilitate an orderly exchange of stock in the corporation for cash
· Often the primary way for family shareholders to realize value from their highly illiquid and unmarketable wealth in company stock
· The most obvious benefit of a buy-sell agreement is that it allows some family members to remain patient shareholders while providing liquidity to family members with other interests or goals
-Come up with stock/cash value immediately
-Valuation issue if privately held
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Storage facilities that are owned by a product or retailer are called---- ----.
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