Family Business Corporate Governance

THE AGENDA FOR TODAY

Family Businesses Importance

Corporate Governance Issues

Wallenberg Business

Dealing with challenges

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Ownership And Control

Family Business

3

Indicators

What is a family business?

A firm of any size is a family business if:

• The majority of decision making rights are the

possession of the natural person(s) who:

• Establish the firm

• Acquired the share capital of the firm

• Are family members of the above (spouses,

parents or direct heirs)

• The majority of decision-making rights are direct

or indirect

• At least one representative of the family or kin is

formally involved in the governance of the firm

• Listed companies meet the decision-making

rights mandated by their share capital

Source: Expert report on Family Businesses, European Commission, Nov 2009

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• Family businesses constitute the world’s oldest

and most dominant form of business

organizations

• Family firms account for 2/3 of all businesses

around the world (HBS);

• An estimated 70%-90% of global GDP annually

is created by family businesses;

• In Portugal family business have a share of

60% to 70% of the GDP

• Between 50-80% jobs of the majority of

countries worldwide are created by family

businesses (European family businesses, 2012).

The Family Business Importance

Examples of family businesses: Salvatore Ferragamo, Benetton, and Fiat Group in Italy; L’Oreal, Carrefour Group,

LVMH, and Michelin in France; Samsung, Hyundai Motor, and LG Group in South Korea; BMW, and Siemens in Germany;

Kikkoman, and Ito-Yokado in Japan; and Ford Motors Co, and Wal-Mart Stores in the United States

5 The Family Business Importance

1. More profitable over the long term;

2. Family business generally take a long term view

and thus balance short-term rewards with long-term

sustainability and prosperity;

3. Generally, they are better for the communities in

which they live and invest more in their communities

both for business investment and in terms of

philanthropic activities;

4. People trust family businesses more than other

kinds of companies;

5. Score significantly higher on things like worker

motivation and leadership, though they lag slightly

on innovation

This form of enterprise has significant benefits to the economy and society at large:

The long-term view of family busniesses performance

Source: Harvard Business Review “What you can learn from family businesses”

6 The Family Business Strengths and Weaknesses

+ Commitment – family usually shows high levels of

dedication to the business grow, prosperity and to

get passed to other generations

Knowledge continuity – Families make it a priority

to pass their knowledge, experience and skills to

the next generations

Reliability and pride –as family name is usually

associated with the business they do their best to

increase quality of the output of their business

(product, service,…)

Partnership – families usually try to maintain a

good and close relationship with their customers,

suppliers, community, employees,…)

Survival– Many family business fail to be

sustainable in the long term. Only 30% survive into

the second generation, 12% into the third and 3%

make it into the fourth and beyond

Complexity - Family businesses are usually more

complex in terms of governance due to the addition

of the family emotions and issues

Informality – as families usually run the business

themselves there is little adoption of business

practices and procedures

Lack of discipline - many family businesses do not

pay attention to succession planning, family

member employment, and attracting and retaining

talent outside family members

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Ownership And Control

Ownership

Family Ownership And Control 8

Principal:

Shareholders

Control

Agents:

Board of Directors

Senior Management

Control Mechanisms: Pressure from Markets Regular Meeting with

ShareHolders Financial Press Scrutiny

Performance related pay

• Separating ownership from management not a

natural in family business. In the beginning ownership

and management are closely linked

• Family business leaders soon become the

bottlenecks for the development of the business and

risk narrowness and weakening the business they

created

• Over time, family business leaders can start stepping back from

operational responsibilities and assume fully their role as owners

(setting the strategic vision which guides investment decisions).

• It is helpful to create a professional board with a few independent

members to bring new perspective and expertise.

• Family business leaders should then be fully-engaged owners of the

business, no longer managers.

9 Stages of Growth in a Family Business

Ownership

Family

This model views family businesses as a complex

system comprised of three overlapping

subsystems: Ownership, Family and Business.

It is a useful tool to understand the different

Dynamics at work in any family business Business

10 Stages of Growth in a Family Business

11 Notes slide 9

• In the developmental theory, family business ownership moves from a Controlling Owner stage

(stage 1) to Sibling Partnership (stage 2), Cousin Consortium (stage 3) and then distant relatives

(stage 4):

• Stage 1: This is the initial step of the family business. The business is entirely owned

• and managed by the founder(s) who usually take the majority of key decisions. This stage is

characterized by a simple governance structure, the control and ownership are in the hands of

the same person.

• Stage 2: This is the stage where management and ownership have been transferred to the

• children of the founder(s). As more family members are now involved in the company,

• governance issues tend to become relatively more complex,

• Stage 3: At this stage, the business governance becomes more complex as more family

members are directly or indirectly involved in the business.

• In the long run (stage 3 and 4) it becomes necessary for the family business to set up the right

governance structures and mechanisms that will allow for efficient communication and a clear

definition of the roles and expectations of every person involved.

Source: IFC Family Business Governance Handbook

Corporate Governance Issues

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01 Succession & Survival

Often the successor is not the fittest choice.

The stock market reacts negatively to the

appointment of family heirs as managers.

Follow the family vision and mission. 30%

survive into the 2nd generation, 12% into the

3rd and 3% make it into the 4th and beyond

02 Conflicts and communication Managing internal conflicts within the family.

Maintaining teamwork and harmony. Keeping

family members informed about major business

accomplishments, challenges and strategic

directions. Keeping focus on same objectives

and interests.

03 Market capitalization

Family businesses have lower stock market

capitalization (lower market value) mostly

due to control issues – whereas markets

downgrade prices due to higher risks for

business (e.g. Tunneling)

04 Professionalization

Few adopt professionalized business practices

and procedures and control mechanisms,

maintaining improper procedures and lack of

internal controls

05 Interconnections

The existence of an additional layer of

relationship that the owning/controlling family

brings to the business. Family participation and

role

06 Capital allocation and

growth Allocation of corporate capital: dividends,

debt, and profit. Family-controlled firms

often face a difficult choice as they confront

the need to fund growth by attracting equity

Six Keys for the Success Corporate Governance Issues 13

Wallenberg Business

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Wallenberg Business

• Separate return (income) from how the company is

run (control)

• Use a Trust or foundation

• Cash-Flow Right differs from Voting/Control Rights

• Dual-class shares (eg. voting caps, cross-

shareholdings, golden shares, staggered boards)

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The biggest challenge for family companies is

how to preserve family control while competing

with public companies that can draw on capital

markets

Wallenberg have the dual-class commons

structure already called as the “Swedish

capital structure.”

Wallenberg Business 16

17 Wallenberg Pyramid

• The Wallenberg family owns 40% of the value

of the Swedish Stock Exchange – 30% of GDP

• Through dual-class shares exercise control

over many companies e.g. 4% by value but

39% by votes

• Wallenberg ownership is exercised through the

Wallenberg foundation

• Companies dominated by investor are run by

professional managers with their own board of

directors

Source: Reproduced from Sundin and Sundqvist (1996).

Wallenberg Business 18

Why are Wallenberg traded at discount?

• The reason for discount is the use of dual-class shares. They give the family more control, but tend

to diminish the value because other shareholders suspect the controlling family will take special

benefits for themselves or start strategic changes to help their own interests rather than the other

investors interests (e.g. tunneling or overinvestment costs)

• Sweden has resisted to end this use of dual-class shares because it helps keep companies under

Swedish ownership under an open economy

• The family claim that they deserve their special rights because of the family´s role in successfully

founding and developing Swedish companies over the years and their tradition of strong and

involved ownership. Also due to social responsibility and natural integration in the Swedish market.

Dealing with Challenges

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Dealing with challenges 20

Develop a family governance structure to bring discipline among family members,

prevent potential conflicts, and ensure the sustainability of the business.

The main components of a family governance structure are:

• A family constitution that clearly states the family vision, mission, values, and

policies regulating family member´s relationship with the business.

• Family institutions, to deal with conflicts and communication issues, e.g. family

assembly, family council, and other family committees.

CORPORATE GOVERNANCE

SUCCESSION

Handling the succession issue: Marrying

intelligent partners who can help them

run their companies, and put efforts in

the education of the next generations.

More exotic Asian-based concepts

include adopting.

CONFLICTS & COMMUNICATION

Develop strong family cultures that not

only serve the companies (eg.

storytelling) but also to handle internal

family conflicts. Family meeting and

retreats

PERFORMANCE

Developing high-performance teams,

including managers outside the family

circle, that stick together for years;

PROFISSIONALIZATION

Adopt business practices that oblige collateral,

information transparency and defined procedures.

That can be done by growing through stock market

capital – that due to covenants and obligations

oblige companies to have procedures in place

(e.g. Sarbanes and Oxley Act)

CAPITAL GROWTH MAINTAINING CONTROL

Trough some concepts already

discussed: pyramiding, dual-class

shares, Trusts Foundation, cross

sharing.

CONTROL MECHANISMS

Performance related pay

willingness to integrate outside individuals in

the Boards

Dealing with challenges 21