How do family businesses survive in an era that’s characterized by rapid economic, social and generational change? Drafting a family constitution and professionalizing family run businesses are possible solutions but how viable are these?
Kavil Ramachandran Executive Director of Thomas Schmidheiny Centre for Family Enterprises at the Indian School of Business (ISB) delved deep into this topic at the Morningstar Investment Conference 2017 held in Mumbai on October 10-11.
The contribution of family businesses is immense. ISB’s research on the listed firms in India found that about 78% of businesses are family controlled. The trend is no different globally. In Europe, 85% of businesses are family controlled. What does this indicate? It means that the economy across the world is driven by family businesses. The destiny of family businesses will determine the economy's destiny or the destiny of the society.
Kavil said that family businesses have a long-term view; they are not driven by quarterly performance. There is continuity in leadership, passion and purpose. Though family businesses are doing well, they tend to disappear as the family grows.
Most family businesses do not survive beyond the first generation or second generation. There are enough examples of such firms around us. To avoid family disputes hampering the business, Kavil recommends that creating a family constitution is the solution.
That said, while most family businesses do not sustain, we also know that family businesses that do well survive, grow and perpetuate. Family businesses have some inherent strengths.
Strengths of family business
Family businesses have to manage the external opportunities and the challenges through its resources both at the firm and internal level. Family businesses have a basket of internal resources. For instance, entrepreneur grooming happens in-house.
On the other hand, most entrepreneurs who have set up their businesses find it difficult to get quality grooming. Besides training, family entrepreneurs have access to economic resources and the social network which helps them build their reputation. “You get industry insights for free. You get committed manpower. You never get free manpower anywhere else. Manpower which will not ask for remuneration, returns, without asking for a stake in the business they will work for you. And above all emotional support. Which is what is required, if you want to build a business or if you are going through a bad patch, if there is some sort of emotional support coming then you are there,” observes Kavil.
Despite possessing such rich resources, why do family businesses get into trouble? Kavil cautions that businesses should not take these resources for granted. Family businesses should handle these resources very carefully. Unfortunately, that’s where most businesses fail.
Treating family and business differently
He recommends that businesses should treat ‘family’ and ‘business’ as two different systems. “What drives families? The harmony, the emotional support, inward looking, continuity, caring, membership in a family is automatic. Once you are born you are a member of the family, you are never thrown out. Equality, is very important in family business. For the elderly every child is equal, independent of the education and capabilities. In essence, what it means is that family is more like a socialistic society. You contribute as much as you can and take as much as you require,” explains Kavil.
On the other hand, in a business set up, membership is not automatic. Unless entrepreneurs are competitive, meritorious, logical, organized and work on a system to drive the decisions, they will not be able to sustain business.
Family businesses blend socialism and capitalism. They extend the same socialistic principles in the business context. “If one sibling is involved in the business every other sibling has a right to go and work in the business. If one sibling is the Director of a business every other member has a right to be Director, whether you have the capability and qualification. If one is getting an expensive car, then everyone else has a right to get the expensive car. So, equality principles are applied in the business. And very often businesses go down because of it. We don’t realize this,” said Kavil.
Sometimes, family businesses take business decisions at the dining table. The Chairman or the Managing Director does not take decisions. It is either the father or the mother. Very often, the mother is not familiar with the business but she would still expect children to obey the father or the elder while taking business decisions.
Shared vision and values
Kavil’s research has found that most families do not have shared values. Family businesses which do not recognize that they wear two hats – ‘family’ and ‘business’ and often end up in trouble. That’s where the governance becomes very important. Businesses need to take care of all stakeholders in a fair way. It requires shared vision and values.
Policies
Moreover, family businesses need well-framed policies in areas like decision making, inheritance and ownership to operate like a professional set up. To draw his point, he cited the example of his interaction with one of his students who had family business. “Some of my students tell me that I worked for my father for 10 years after my graduation and he said there was some difference of opinion and asked me to get out. The student said he doesn’t know what to do. So, there is no rule about that, there is no clarity about that,” said Kavil.
Rewards
Similarly, Kavil said that businesses need to have a clear policy on rewards. The rewards should be standard across generations. For instance, it is good to have a policy on the use of credit cards. He cited the example of a family in Delhi which went into dithers just because one of the brothers used Mercedes Benz for the wedding.
Decision making
In a growing family business, decisions are taken on an ad-hoc basis without consulting all members. This leads to a trouble. Thus, family businesses also need proper processes for taking decisions. How decisions are arrived at, implemented, controlled and corrected. One solution could be setting up a family board. This board should have fixed agenda and record the minutes.
For overcoming all these hurdles, writing a family constitution can be a solution. “While writing a family constitution, what happens is that you are looking at the purpose of the family being together you are writing down the policies and the policies are prepared through a process of discussion. Several rounds of scenario building, what happens if nobody is there, if there is somebody coming back from work and want to join the family business what happens. What about the investment? What about the daughters? What about people who are retiring? How are you going to do that? Just like a business, strategic planning, scenario building is very important for families,” explained Kavil.
While drafting a family constitution, scenario building process helps in drafting well-articulated policies and processes. Kavil suggests that businesses should refrain from outsourcing this task as the recommendations of the consultant do not help in most cases.
Here is the conversation with the moderator Vishweshwarayya K, Associate Director – Product Management, Morningstar where Kavil answers audience questions.
Vishweshwarayya K: How would you rate the corporate governance standards in India versus other markets, given the large number of businesses that are run in India are family owned?
Kavil Ramachandran: I haven’t looked at it from a comparison angle. But in an absolute sense I’m unhappy with the level of corporate governance in India. I find that many families do not have a very strong, either commitment or even understanding of the relevance of family governance. It has become more of a ritualistic kind of thing - compliance requirement. When I talk to family businesses many of them are not very clear about its purpose. So, there is a process of education required for families to raise awareness about this issue.
Vishweshwarayya K: Is it ethical for the next generation to take over key positions like CEO/MD in family run businesses?
Kavil Ramachandran: If a family member wishes to occupy a position in the family business the position should be very clear. Family membership and ownership hat should not be the criterion for anybody to occupy any position in corporate. For instance, Murugappa Group has a clear policy that you cannot reach the top just like that. You have to start at the lowest level. The next generation should be allowed to enter only if they have the relevant qualifications and experience.
Vishweshwarayya K: How do financial advisers make inroads in family business in terms of acquiring business?
Kavil Ramachandran: Financial advisers need to have empathy. They should not approach family business with the sole intention of getting business. Rather, they should build trust which will help them break the barriers. Advisers should understand family governance. I know two family offices in India where, bankers who resigned and they started family offices, but then soon within six months to one year they realized that they were not getting any business, primarily because they were going and talking only about business, about investment, about their wealth.
Few family business owners have told me that they took ages to build business and wealth and how can they trust a stranger to manage their finances. So building trust is very important. Contributing that governance is very important. Wealth mangers should understand the importance of family governance and try to be change agent in a direct, indirect way and don't just start selling products in the first meeting.
Vishweshwarayya K: In your experience what is the best way to handle conflicts in a family business?
Kavil Ramachandran: There are five Ds. It starts with dilemma which leads to deviations in behavior. Deviations lead to differences. Differences lead to disputes and disputes lead to destruction. So, it depends which phase it is. If it is already close to the disputes and destruction stage it is very difficult to recover. Secondly, dilemmas are happening because there are no policies. So, if you tell them that one is that create that family education part of it. So that’s where I think whoever is interested should start and then I think there is need to have individual meetings to understand the fundamental things. Most often, it is because of poor communication.
Vishweshwarayya K: Many entrepreneurs don’t want to retire. How do you convince them to retire?
Kavil Ramachandran: Never retire. If you look at your own life, from childhood there is a portfolio. When you are child your primary portfolio is eating, sleeping, playing. When you are in the college or studying there is another portfolio. When you start working there is yet another portfolio. So, as you start growing older, you need to have a portfolio of activities. It's not 18-hour work. I would say that when you turn 50, it is not a very old age. But you need to start having multiple portfolio, and have that flexibility to relook to change that portfolio. People should start early to look at what next, what are the other exciting things around.