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More than 70% of companies with revenues of over $1 billion in India are owned by families—and it is a good thing for the economy. First, family-owned businesses globally perform better on average than other businesses and have better odds of staying in the Fortune 500 list year-on-year. They also help focus the country’s capital on long-term investments, while public sector companies struggle with the challenge, simultaneously planning for the future and meeting expectations in terms of quarterly earnings.

Unlike family-owned businesses in mature economies, India’s are relatively young, with many still in the hands of the first or second generation. As a result, most business families still need to build their knowledge on how to govern a business with multiple family owners, and many still need to build a succession plan. In the next 15 years, 40% of India’s large family businesses will undergo a handover from the founder to the second generation of owners, and 35% of them to the third or fourth generation.

As India Inc. enters this critical phase, it is time to act. This article is the first of a series that describes the roles that owners of family businesses must play for their businesses to stand the test of time.

CREATING LONG-STANDING INSTITUTIONS

After building business empires, many founders aspire to leave a legacy behind in the form of a long-standing institution which embodies a certain set of values. Everyone stands to gain—the family, by carrying a prosperous and meaningful lineage; the economy, through growth and innovation; and society, through job creation and social advancement.

An example of successful institution building is the Ayala Corp. based in the Philippines. It was founded in 1834 and is now run by the family’s seventh generation. Ayala is responsible for numerous milestones in the history of the Philippines, including its first printed currency and its first ATM network. It has also set up a foundation which is spearheading the effort to eradicate poverty in the country. Closer home, the Tata trusts have created no less than eight major educational institutions such as the Indian Institute of Science and the Tata Institute of Social Sciences.

Creating long-standing institutions is a difficult task and requires different skills compared to business building. Regardless of how strong the foundations of the business might be during the founder’s time, they can be shaken once the reins are handed to the next generation. Very few families are able to create the stability required to deal with transitions and many are unable to make it to the third generation. Things become difficult by the fourth or fifth generation, when the lineage increases to include several others.

PITFALLS FAMILY BUSINESS OWNERS NEED TO AVOID

Observing the downfall of once-flourishing family-owned businesses, there seem to be three major pitfalls that owners could be aware of and avoid: lack of governance and succession rules, diverging vision and values among family members, and the absence of next-generation leaders to run the business.

Governance and succession rules

The story of a well-known American business family best illustrates the importance of laying out a charter or set of rules to cope with governance issues. It also outlines how decisions should be made when the interests of family members diverge. In the late 1990s, when a second- generation business entrepreneur passed away, the baton of group chairman passed onto his son, who was expected to “figure out an appropriate succession process" to the 10 cousins. As early as 2001, tensions began to emerge in the family as most cousins were pursuing independent careers and wanted to manage their share of the wealth themselves. What ensued was a 10-year-long process to settle the business shares and split the businesses among the family members. The family eventually reached a peaceful settlement and even managed to grow the company’s value threefold during the period, but such amity and growth is more the exception than the rule.

One of the most important roles of a business owner is to take the key decisions, define the decision criteria, the governance process to arrive at these decisions, and the time frame and communication process. This is a critical exercise which requires leadership.

The Ayala brothers in the Philippines wrote a formal constitution with their father, which prevails even today. Large business families also often rely on a set of councils appointed to resolve divergences or evolve the family’s rules. These can include a shareholder assembly and a family assembly where all shareholders or family members can express their views, as well as executive councils which make the final decisions. The Al Muhaidib family council, for instance, takes decisions pertaining to the family youth’s education, business ventures and careers outside the family group.

The rules should also cover succession in a way that maximizes chances of the business remaining in the family. An innovative agreement signed by a renowned family who were based in London, Paris and Frankfurt, stated that if the heirs of a deceased partner in the company were to take legal action against living partners over succession matters, a third of their shares would go to the poor of the three cities. Recently, G.M. Rao of the diversified infrastructure conglomerate, GMR Group, got a family constitution drafted to deal with matters regarding ownership and power sharing.

Diverging vision and values of family members

Even with clear governance and succession rules, things can go sour if the values and vision of family members are radically different. In many cases after the founders’ departure, the families are unable to reconcile their differences on how to run the business, and often split. A well-known American business family went through lawsuits and business splits when one of the fourth-generation members started questioning the management ethics of his uncle who was at the helm of affairs. The lifestyles and culture of different branches of the family had diverged at a rapid pace after the death of the founder and they were unable to reconcile their different views on how to run the business. Some families try to prevent this by documenting the family values and by organizing events where family members are encouraged to reflect upon these values.

Creating alignment on vision and values among family members is an important role family business owners must play. Family leaders must work to ensure that the vision and values of the new generation remain compatible with collective business ownership and lifestyles are similar across the family. It is also important to share a vision, looking ahead to how the business should grow over the next 10 years and establish a common understanding of goals.

A set of written family and business values is a helpful tool. For example, the Tata group has built brand usage agreements to define business- and ethics-related codes that participating businesses support and abide by. This has allowed the group to retain, through Tata Sons, the governing approach with aligned vision and values while allowing its businesses to grow organically. Alternatively there are also less formal, but effective approaches like those taken by the Al Muhaidib family which runs an annual event with a different theme each year depending on the aspect of the family culture they want to emphasize.

Next-generation leaders

Failing to identify and develop next-generation leaders is the third pitfall. First, not empowering successors can prevent the business from having a consistent approach and strategy, as was the case when one of the patriarchs frequently overruled his son even when he was the president of the company. The most challenging situation is when no clear successor is identified. J. Paul Getty, who was the world’s first billionaire in the 1950s, fired three of his four sons from the business as he considered them incompetent, and never let his other son make independent decisions. After his death, the oil business was sold off to another oil company.

Most business owners assume that the next generation will run the business competently. In some cases they may have the skill to do so, but may not have been given the right opportunities to work hard and learn through difficult business challenges. Sometimes, they don’t have the required capabilities, but are convinced that running the business is the only honourable option. In reality, the children of founders or owners do not necessarily need to run the business themselves. It is an unrealistic expectation to assume that children will have the aptitude of high-performing CEO parents, generation after generation. In fact, they may be young and inexperienced and have relatively limited knowledge of the business, its culture and its customers. The primary role of business owners is to train children as business shareholders, after which they can consider giving them business roles. If not interested or capable, external leaders will need to be identified to take the business forward.

A few years before retiring, it is absolutely critical for a family business owner to develop leaders who will run the business going forward. Creating the right top team easily takes five years. The business owner must identify the right talent—both internally and externally—and provide challenging assignments, along with coaching and increasing responsibilities. Throughout this process, the family business owner must transmit knowledge and experience, and progressively let go of responsibilities to focus on mentoring. This is what N.R. Narayana Murthy did as Infosys’s chief mentor from 2006 to 2011.

A family business needs committed stewardship to remain viable. Business owners need to be realistic and identify who to hand the baton to—someone within the family or somebody external, who will uphold the values and vision and take the business forward.

Handling generational transition can be challenging for family business owners, especially founders. While they often grow the business step by step depending on opportunities, the mindset for turning a business into an institution that will last generations is different. It involves a long-term vision, and a lot of backward planning from the age of expected retirement. Business owners who are used to relying only on themselves and a small number of trusted leaders will face the challenge of developing leaders, empowering and mentoring them. Eventually, the ability of business owners to change their mindset and play a proactive role is what can make the difference in turning a successful business into an institution that stands the test of time.

This is a part of McKinsey Leadership Institute’s series of articles on family-owned businesses.

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