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Friday, 22 May 2020

Family-owned companies

In 1602, a global watershed moment took place when the Dutch East India Company was founded. From that moment, ownership, management and capital (ie, funding) were no longer in one (family) hand. However, little has changed over the past 400 years. Family-owned companies are still the majority of all businesses worldwide. Why?

The most logical explanation is that family-owned businesses simply show a better performance. My son's thesis shows many sources validating that assumption. I will elaborate on several of these performance indicators.

Generally, most small-sized family companies cannot afford hiring external management (eg, salaries, pensions). The difference between turnover and cost will equal owner remuneration. Often, such family companies operate in retail and are nicknamed mom-and-pop stores.

For medium and large-sized family companies the risk-reward trade-off will determine whether they will look for external funding (eg, banks, partners, stock exchange). As long as the risks are within their risk appetite, they will not open up their companies to external parties.

The Dutch East India Company faced exactly that dilemma: immense rewards and huge risks. One failed mission could bankrupt a previously wealthy family. The solution was to share rewards and offload risks. After 400 years, these companies are still the "exception". Why?

The past 400 years have shown some (further) advantages and disadvantages when comparing family-owned and other businesses. Unlike owners, managers often have a short-term focus following the nature of their remuneration (ie, fixed salaries), despite its enhancements (eg, bonuses, options, shares). Hence, managers resign and these companies lose experience.

The risk-reward trade-off has changed in non-family companies: management bears the risk while shareholders reap the rewards. This increases the risk profile of such companies as the interests of management and shareholders are no longer aligned (eg, bonuses versus continuity).

A further increase in risk profile is employment turnover. Large transactions (eg, acquisitions, international expansion, ICT projects) are successes claimed by current managers but will become nightmares for subsequent managers.

Hence, family-owned companies (should) benefit from the above by a lower cost of external funding. As usual, the devil is in the details. Banking conditions of family-owned companies may show a personal liability for the owner(s), unlike directors of public companies.

The risk-reward trade-off - and lower risk profile - is the reason why family-owned companies still rule the corporate world, despite 400 years of public companies.

We Are Family (1979) by Sister Sledge


Note: all markings (bolditalicunderlining) by LO unless stated otherwise.

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