Family Business presentation by McKenzie

1. 94
Keeping the family
in business
Heinz-Peter Elstrodt
Very few large family-owned enterprises thrive beyond the
third generation. Those that do find ways to run themselves
professionally while making the family happy.
I n advanced economies, as well as in emerging markets, most compa-
nies start out as family-owned businesses. From their humble beginnings,
driven by entrepreneurial vision and energy, some have grown to become
major forces in their economies. Indeed, this still happens not only in emerg-
ing markets, with their chaebols in South Korea and grupos in Latin America,
but also in North America and Europe, where relatively young family-owned

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PHILIPPE WEISBECKER
businesses such as Wal-Mart Stores, Bertelsmann, and Bombardier, to name
just a few, have become front-runners.
But family-owned businesses—companies in which a family has a control-
ling stake—face a sobering reality: the statistical odds on their long-term
success are bleak. In fact, a number of studies, taken together, suggest that
only 5 percent continue to create shareholder value beyond the third genera-
tion. This statistic should come as no surprise, given the business challenges
any company faces in increasingly competitive markets, to say nothing of
the difficulty of keeping growing numbers of family shareholders committed
to continued ownership. One kind of risk for these businesses comes from
the generations that follow the founder, whose drive and business acumen
they might not match, though they may insist on managing the company.
By the time the third generation takes over, the scene is set for squabbles
among members and branches of the ever-expanding family. Rather than
looking after the interests of the business, they may fight over the size of the
dividend payouts, the composition of the board, or who gets to be chief
executive officer.
Nevertheless, a few family-owned businesses defy the odds and continue to
thrive generation after generation. To gain a better understanding of how to

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build and manage family businesses that last, McKinsey conducted inter-
views with the family leaders—either the chair of the board or the leader
of the family holding—of 11 family-owned businesses. Of these, 9 were in
the United States and Europe and 2 in emerging markets, where such busi-
nesses make up a much larger part of the economy but are
mostly quite young. All of the companies are at least 100 years
old—the youngest in its 4th generation, the oldest, founded
more than 250 years ago, in its 11th. These survivors are
not only venerable but also large and successful. Of the 11,
7 have revenues of more than $10 billion, and the families
that own 6 boast a net worth of more than $5 billion each.
All have delivered growth and profits over recent decades
and are financially solid, with low debt-to-equity ratios.
The companies in our sample—a few of them public—have made it through
economic depression, war, and other forms of turmoil, with the families
remaining in control. Their experience has great value for younger family
businesses whose owners face a generational transition and must decide
whether and how to embrace the challenge of creating an enduring business
under family control.
For the companies in the sample, the key to survival and success was strong
governance in its broadest sense: a powerful commitment to values passed
down through the generations and a keen awareness of what ownership
means. Ownership is both a blessing and a curse, giving the family the power
to destroy the business as well as to shape it and enjoy its returns. The fami-
lies that own the businesses in the study recognized this danger and estab-
lished systems of checks and balances for carrying out the family’s roles in
the three vital dimensions of governance: ownership, board supervision,
and management.
In what is usually a patchwork of oral and written agreements—some
legally binding, some not—the family addresses issues such as the composi-
tion of the company board and how it should be elected; which key board
decisions require a consensus, a qualified majority, or interaction with the
shareholder assembly; the appointment of the CEO; the conditions in which
family members can (and cannot) work in the business; how shares can (and
cannot) be traded inside and outside the family; and some of the boundaries
for corporate and financial strategy. These arrangements, typically developed
over many decades, help defuse the often highly charged issue of the succes-
sion of power from one generation to the next and lay the foundation for
fulfilling the two main conditions for the long-term success of any family-
owned business: professional management and the family’s ongoing commit-
ment to carry on as the owner.

4. K E E P I N G T H E F A M I LY I N B U S I N E S S 97
Running the business well
With a set of clear rules and guidelines as an anchor, and with family con-
flicts comfortably at bay, family-owned enterprises can get on with their
strategies for long-term success. Some key factors show up over and over
again: strong boards and uncompromising standards of meritocracy in per-
sonnel decisions, risk diversification and business renewal through active
management of the business portfolio, and long-term financial policies.
Powerful boards
Strong boards are particularly important in family-owned enterprises to
complement the family’s business skills with the fresh strategic perspectives
of qualified outsiders. As a fourth-generation family leader said, “We must
not be managers. We must be experts in corporate governance.” Indeed, the
corporate-governance practices of
most family businesses in the study
surpassed those of average public As a family leader said, ‘We must
companies. not be managers. We must be
experts in corporate governance’
Even when the family holds all of the
equity in the company, its board will
most likely include a significant proportion of outside directors. One family
has a rule that half of the seats on the board should be occupied by outside
CEOs who run businesses at least three times larger than the family busi-
ness. Another private family business set up an independent institution solely
to nominate and elect one-third of the board members. But in most of the
companies, the family nominates and elects the outside board members.
The procedures—for all nominations to the board, not just nominations of
outsiders—differ from company to company. One board perpetuates itself:
it selects new members and then seeks approval by an inner family commit-
tee of around 30 members and formal approval by an assembly of share-
holders. In another company, board members are elected, on the principle
of one share, one vote, from a list of candidates at a meeting of all share-
holders. A more common approach is for a limited number of family
branches to pool their holdings and elect a block of board members. The
formal mechanisms differ; what counts most is that the family must under-
stand the importance of a strong board.
All of these boards become deeply involved in top-executive matters and
manage the business portfolio actively. Many have meetings stretching
over several days to discuss corporate strategy in detail. In most of the com-
panies, the chair and the vice chair typically spend at least half of their time

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interacting with other board members, top management, and the family,
which is kept informed about the business through newsletters, informal
gatherings, and regular reports.
True meritocracy
Nepotism is the obvious way to destroy a family-owned business in a single
generation—and this happens, all the time and all over the world. To control
the natural human desire to favor your own kin, family-owned businesses
that want to last for generations must establish a true meritocracy, as all the
companies in the survey did.
Half of the families had decided not to have their members involved in man-
agement at all. “Y cannot expect the family to consistently generate com-
ou
petent top managers,” one family leader said. Another noted, “My uncle,
who had been appointed chief executive, died early. Otherwise, he would
have ruined the business.” A third leader said, “Our key factor of success is
that we hire the best people in the market, and if they turn out not to be the
best, we fire them. We would not be
able to do that if we had family
‘You cannot expect the family to members in management.”
consistently generate competent
top managers,’ said one leader In the remaining companies, family
members who have proved their
competence are welcome to serve
as managers. Two of the companies require family members to start work
outside the family business. After they have had 10 to 15 years of highly
successful experience, its board may invite them to hold top-management
positions. Said one family CEO: “I was surprised to be invited to run the
company, but I guess the family found me competent.”
At the other companies, family members can enter the business after gradua-
tion and work their way up. Their performance and career prospects are
usually evaluated every year, often by competent outsiders reporting directly
to the board. If such family members lack the potential to become top man-
agers in the long term, they leave the company. “Our policy is up or out,”
one family leader said. “Nobody gets promoted because he or she is
family—rather, the opposite.”
One family member and CEO of a privately held company explained in great
detail how he was put through a two-year process of outside evaluation and
coaching before a board committee appointed him to the position. Another
company uses a recruiting firm to find alternative, outside candidates for

6. K E E P I N G T H E F A M I LY I N B U S I N E S S 99
every top-management position and sometimes appoints
them. Harsh as these policies may seem, they safeguard
the family’s long-term interests.
Diversification strategy
Most of the family-owned businesses in the study are
privately held holding companies with reasonably inde-
pendent subsidiaries, which might be publicly owned,
although most of the time the family holding company fully controls the
more important ones. By keeping the holding private, the family avoids pres-
sure from outside shareholders for quick, high returns and thus allows the
company to pursue diversification strategies to achieve steady profitability
and survival over shifting business cycles. This approach might not make
sense for a purely financial investor, but families that aim to keep control for
generations have a different perspective. “We want to provide diversification
for our shareholders within the business so that they don’t have to take the
money out and do the diversification themselves,” one family leader said.
All of the family-owned businesses surveyed see themselves as conglomer-
ates, not as single-business companies. While some have a wide array of
unconnected businesses, most focus on two to four main sectors. They all
seek a mix between businesses with high risks and returns and businesses
that have more stable cash flows. Many of them complement a group of core
businesses with venture capital and private equity arms in which they invest
10 to 20 percent of their equity. The ability to react quickly to opportunities
that come up through these families’ extensive networks is important: in one
case, a timely investment of $5 million a few decades ago turned into a large
stake in a $50 billion company. The idea is to renew the portfolio constantly
so that the family holding can preserve a good mix of investments by shift-
ing gradually from mature to growth sectors. For the company to survive, it
is necessary to focus on the enterprise as a whole and not to be sentimental
about individual businesses. Many companies in our sample had departed
the founding core business—always a traumatic decision.
In most of the companies studied, the criteria for selecting new opportunities
were clear: asset-light businesses such as retailing, consumer goods, and
trading were preferred to asset-intensive ones, to avoid competition with
publicly traded companies that have better access to capital and—in the
1990s—often favored growth over profits. Several family-owned companies
in our sample exited asset-intensive businesses, though they were performing
well and fitted nicely into the portfolios, for fear that they could drain off
financial resources in the long term. Niche businesses—those competing in

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small world markets—are also popular, because they give the family control
and a chance to be globally active without becoming financially and organi-
zationally overstretched.
The financial policies of the companies are consistent with their risk-averse
portfolio strategy. Those in the study pay lower dividends than most public
companies with similar levels of performance, because reinvest-
ing profits is the only way to expand a family-owned business
that doesn’t want to dilute ownership by issuing new stock
or to assume big amounts of debt. For many families a side
benefit of this policy is that members do not amass (and
possibly waste) large individual fortunes but rather stay
focused on their ownership role.
These companies’ debt targets are conservative too, par-
ticularly for the holding company, which usually aims to
have a 0 to 20 percent debt-to-equity ratio. Many don’t
guarantee the debt of their subsidiaries. “We explicitly
tell all financial institutions we will not bail out a sub-
sidiary in trouble. This makes debt more expensive at the subsidiary level,
but protecting the family’s wealth makes it worth it,” one family leader said.
Long-term-performance focus
These family-owned survivors share a strong performance culture combined
with quantitative targets for growth and returns. One business in the study
aims to have returns 25 percent above the relevant stock market index: as
the company’s leader said, “Why would you keep the family business if it
returns less than the stock market?” Interestingly enough, when asked
about historic returns, none of the family members interviewed for the study
quoted the quarterly performance of the companies or even their perfor-
mance over 1 or 2 years. The minimum period mentioned was 5 years, and
one to two decades was more common. Over the past 10 to 20 years, most
of the companies have enjoyed shareholder returns at or above those of stock
market indexes.
Economic cycles are a fact of life for family-owned businesses that have a
very long past and anticipate an even longer future. “We have survived world
wars and hyperinflation. We never expect good periods to last very long; nei-
ther do we expect that from bad periods,” one family leader said. To sum up,
these companies are performance oriented but risk averse, which might make
them less successful in boom times but keeps them alive, with healthy prof-
itability, over the very long term.

8. K E E P I N G T H E F A M I LY I N B U S I N E S S 101
Keeping the family happy
No family-owned business survives for long unless it is run professionally.
But ensuring that members of the family want to carry on as owners genera-
tion after generation is equally important.
Outsiders may wonder why the family should bother with all the hard work;
why not sell the company and let each family member invest the proceeds
on capital markets? Leaders of family-owned survivors often argue that a
pooled and professionally managed fortune stands a better chance of surviv-
ing and growing than it would if it were split, sometimes into hundreds of
parts, each invested separately. That is an arguable point, and not all family
members agree. But family-owned businesses undoubtedly offer noneco-
nomic benefits too: a respected position in society, the pride and the sense
of belonging that come with carrying on a family tradition, and the chance
for some members to work in the
business and for others to pursue
shared interests alongside it. Leaders of family-owned survivors
often argue that a pooled and
Successful old family-owned busi- professionally managed fortune
nesses have found many ways to hold stands a better chance of survival
families together as owners. Private
ownership serves as an incentive for
families to stay with companies by allowing them to pursue diversification
strategies that make it safe to keep most family wealth at home. It also func-
tions as a disincentive to exit because there is a large market discount—
often 20 to 50 percent of the estimated economic value—for the shares of
privately held companies as a result of low liquidity and the frequent lack of
voting rights.
To counter nonfamily ownership, many family-owned businesses also restrict
the trading of shares. Family shareholders who want to sell must offer their
siblings and then their cousins the right of first refusal. In addition, the hold-
ing often buys back shares from exiting family members through a share
redemption fund. One company decided generations ago that shares could
be sold only at prices well below their book value (usually two to three times
less than the estimated market value) and only to other family members.
Indeed, at the core of a durable family enterprise is the philosophy that own-
ership implies, not necessarily the right to sell, but rather the responsibility
of handing a stronger company over to the next generation.
Of the family-owned businesses in the study, two had gone through serious
crises in the past few years—one the result of business problems, the other

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of difficulties in the interaction between the family and management. In
both cases, the basic ownership structure made it unattractive to sell, so the
family had an incentive to work problems out—and actually did so—rather
than give up. Had these been public companies, their performance might
have suffered much more and their ownership could have changed.
Because exit is restricted and dividends are comparatively low, some family-
owned businesses have resorted to “generational liquidity events” to satisfy
the family’s need for cash. These events may take the form of sales of pub-
licly traded businesses in the holding
or sales of family shares to employ-
One of the attractions stressed by ees or to the company itself, with
many interviewees is that family- the proceeds going to the family.
owned businesses contribute to a One chairman said of his company,
more meaningful way of life “Every generation has a major
liquidity event, and then we can
go on with the business.” Liquidity
events can be staged; for instance, members of the family might have the
right to sell their shares every five years at a price calculated by preestab-
lished rules, but the total volume might be limited and the payments staged
over a couple of years to avoid straining the company’s finances. Moreover,
the families that own some of the companies don’t derive much economic
benefit and accept this because they have been educated to do so.
As generations come and go, every old family business faces the challenge
of making continued ownership attractive to an ever-larger family of which
only a few members play any role in management. One of the attractions
stressed by many interviewees is that family-owned businesses contribute to
a more meaningful way of life. This lifestyle often centers on separate family
institutions: a family council might be responsible to a larger family assem-
bly, which may be used to vent family disputes and to build consensus on
major issues.1 The council might also oversee a family office, financed by the
business, that assists family members who want to pursue common interests,
such as social work, often through large charity organizations linked to the
family office. Charity is a way to promote family values, to provide mean-
ingful employment for family members not active in the business, and to
involve young ones in real decision making; a group of 14- to 18-year-olds,
for example, was granted an annual budget of $100,000 to distribute to
charity. As one head of a family holding said, this kind of activity “brings
the group together”; family members “analyze issues and work together to
form a strategy. They learn a lot about responsible decision making and
about following through.”
1
See Luis F. Andrade, Jose M. Barra, and Heinz-Peter Elstrodt, “All in the familia,” The McKinsey
Quarterly, 2001 Number 4 special edition: Emerging markets, pp. 81–9 (www.mckinseyquarterly.com
/links/7427).

10. K E E P I N G T H E F A M I LY I N B U S I N E S S 103
Another way to keep the family happy is to provide services to its members.
Asset management is the most prominent, but others may be equally impor-
tant—for example, tax services, educational advice for new generations, and
even concierge services. Some of the family offices employ as many as 40
professionals.
The family office may also be involved in organizing regular family gather-
ings, sometimes bringing together hundreds of members from around the
world. These get-togethers offer large families a chance to bond, to discuss
family and business matters, and sometimes to vote formally or informally
on important propositions. No less significant is the opportunity to enlighten
the younger, sometimes pampered, generation about the realities of running
a big family-owned business. To help the children understand the complex
skills and hard work required to do so, many families let their youngsters
visit or serve internships in companies they control.
Leo Tolstoy’s famous observation that “Happy families are all alike; every
unhappy family is unhappy in its own way” may hold some truth for family-
owned businesses too. The similarities among the approaches used by a wide
range of successful survivors certainly offer food for thought to younger
companies aspiring to join their ranks.
Heinz-Peter Elstrodt is a director in McKinsey’s São Paulo office. Copyright © 2003 McKinsey &
Company. All rights reserved.