Chapter 1

An Overview of the Family Business

Common Misconceptions of Family Businesses

Business historian Alfred Chandler assigned blame for the economic decline of Great Britain on family businesses. He described them as backward and small scale, with an inability to preserve financial capital.¹ Many still hold this negative view today. Many of the terms used when discussing family businesses can be condescending: small, unprofessional, rife with conflict, unable to compete, nepotistic, often failing to succeed, financially underperforming, unfavorable work environments, slow growing, and supplying of dead-end jobs.

Critics cite the high failure rate of intergenerational transfer (succession) as evidence that family businesses are not well-­run businesses. Some of this criticism is well founded: Family businesses can be unprofessional. Many people have witnessed a small family-­owned business in which one family member berates another family member in front of customers or has acted in an unprofessional manner. This book will discuss each of the misconceptions and will present differing, and often contradictory, information for readers to compare and consider.

Definition of the Family Business

A family business can be defined in multiple ways. There may be as many as 34 definitions.² The variety of definitions makes comparisons and generalizations difficult, which is a large part of the reason for the varying reports of levels of financial return and the contribution from family businesses to the economy. The breadth of definitions complicates having an accurate number of family businesses in the United States and the world. The following are a few of the various definitions of family business:

A family member is chief executive, there are at least two generations of family control, a minimum of five percent of the voting stock is held by family or trust interest associated with it.³

One in which a family has enough ownership to determine the composition of the board where the CEO and at least one other executive is a family member, and where the intent is to pass the firm on to the next generation.⁴

The family business is a business governed and/or managed with the intention to shape and pursue the vision of the business held by a dominant coalition controlled by members of the same family or a small number of families in a manner that is potentially sustainable across generations of the family or families.⁵

Erenesto J. Poza, in his widely used text Family Business,⁶ defined family business as

1. ownership control (15% or higher) by two or more members of a family or a partnership of families;

2. strategic influence by family members on the management of the firm, whether by being active in management, continuing to shape culture, serving as advisors or board members, or being active shareholders;

3. concern for family relationships;

4. the dream (or possibility) of continuity across generations.

The need for a universally accepted definition of family business was exemplified in the research of Astrachan and Shanker,⁷ which assessed the contribution of family businesses to the U.S. economy. Family firms make up 24.2 million businesses in the country, accounting for 89% of all year 2000 tax returns, according to their broad definition of what constitutes a family firm. Conversely, in a more narrow definition, there are only 3 million family firms, accounting for 11% of all year 2000 tax returns.⁸ The definition of what is, and what is not a family firm is vital for family businesses and practitioners—not just for family business scholars. For the family to take advantage of the scholarly research, the discipline must be grounded in a common definition; otherwise, it is a little like comparing apples to oranges. For example, the small corner store has different problems, issues, and opportunities than Wal-­Mart has, yet both are considered family firms.

The definition used in this book will be the broadest possible in order to provide an overview of the subject matter. Two things are important: More than one family member is involved in the firm as an owner, and the family exercises some type of control. This definition allows us to discuss the more prevalent small family-­owned businesses as well as giant family-controlled multinational firms.

Prevalence of Family Businesses in the Global Economy

Family businesses are present in every country around the world. Often, family firms collectively dominate the economy of their particular country or region. This is the case in Latin America and South America, where groupos are prevalent and account for a majority of the gross domestic product (GDP). A groupo can be defined as an intertwined group of companies controlled by a large interrelated group of family members with key family and kinship partnerships. Since the markets of each country are relatively small in South America and Latin America, a family business often comes to dominate a certain industry, with a significantly large share of its particular country’s market. To support the growing family, the decision is often made to diversify, usually vertically or horizontally, by buying suppliers or distributors. The firm then puts family members in control of the new organization. The result is a large web of closely related but tightly knit firms, who, in effect, are controlled by the original founding family.

In Japan, the large family-­controlled zaibatsus, such as Matsushita and Sumitomo, were the dominant form of business in the first part of the 1900s until World War II when they were broken up by the government. These family firms evolved into interrelated keiritsu, a type of holding company usually dominated by a bank. One of Japan’s biggest companies, Toyota, is controlled by the Toyoda family. In Korea, the economy is dominated by chaebols (large interrelated groups of firms) such as Samsung and Hyundai. Indonesia is dominated by family-­owned enterprise groups. Many European economies rely on family-­owned businesses and financing from banks, as the capital markets and access to venture capital are less developed than in the United States. The European stock exchanges are typically dominated by large, well-­established corporations, which make up only a small part of Europe’s economies. As an example, family-­owned businesses with less than 500 employees (called mittelstands) account for 79% of the employment in Germany. Sweden’s economy is dominated by a single family. In the 1990s, the Wallenberg family controlled almost 40% of the shares traded on the Stockholm stock exchange. In the 1970s, more than 10% of all private-sector employees worked for a Wallenberg company.

In many high-­growth emerging markets, family-­owned firms dominate and are especially beneficial to the industrialization and early-­stage development of the country’s economic infrastructure. Many family firms hold dominant places in the channel of distribution as middlemen or wholesalers. Due to their usual flat organizational structure, owner-­managed firms do not have the layers of management bureaucracy that nonfamily firms have, and they can make rapid decisions to enter a market, finance an expansion or acquisition, or make a divesture without taking up valuable time. This allows family firms to enter an emergent market with a first-­mover advantage, establish distribution, and tie up valuable resources, which can lead to a sustainable competitive advantage.

John D. Rockefeller, founder of Standard Oil, was the world’s first billionaire. He monopolized the location, production, and distribution of oil and kerosene. His son, John D. Rockefeller Jr., is credited with creating the modern process of philanthropy, as we know it today, by establishing the Rockefeller Foundation. Family firms have played a more important role in the global economy as bankers. Both the Morgan and the Rothschild families have hundreds of years of experience in investment banking and financial services. The Rothschild’s family financed the creation of De Beers (diamonds) and became a large stockholder in it. Powerful J. P. Morgan was instrumental in preventing the U.S. financial system from failure before the creation of the Federal Reserve System.

In addition to the United States, the prevalence of family business in countries and regions around the world is sizable. Their impact on employment and their countries’ economic output is considerable, as shown in Table 1.1.