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It is well known that family businesses are critical engines of economic growth. These entrepreneurs play a critical role in creating jobs, providing income and generating wealth. There are three questions that we address in this article with a focus on what professionalization truly means.
Do family-owned companies (FOCs) perform better than non family-owned companies (NFOCs)?
A recent study by BCG Value Science Centre showed that in India, FOCs have systematically and significantly outperformed NFOCs by 920 basis points on total shareholder returns (TSR) over the last decade, delivering an 18.7% annual return compared to 9.5%; that’s nearly 2X. Studies in other markets over different time periods also indicate outperformance by FOCs, though not to the same extent as in India over the last decade.
When does it make sense for a family-owned company to turn professional?
Most (if not all) entrepreneurs have high energy, deep conviction in their ideas, and risk appetite, and do a great job of getting the business from 0 to 1 (or 10). Some entrepreneurs hire ‘professionals’ to manage the company at a certain stage in its evolution.
Some common themes that drive this are: a) the recognition that scaling up a business needs a different skill set; b) lack of interest or desire in the next generation; and c) too many members in the family and need for a neutral party to manage the business. Of course, there are some companies that retool themselves and have the family member(s) run the business but in a different manner.
How does one identify whether a company is truly ‘professionally run’?
We identify four signs of ‘professional’ family-owned companies. In our view, these signs are a barometer to assess how well run these companies are and what makes them distinctive compared to other family-owned companies.
Firstly, the promoter group maintains a separation of ‘church and state’ between the family and company. Its mindset is that the company does not belong to them. But what does it mean in practice? At a respected FMCG company, the management has been very thoughtful in business relationships (with vendors/partners) that have linkages to the family. They have to clear the same (if not higher) bar as a regulator partner. The chairman has been explicit and clear about this, not only with the management but also the broader family: Address the issue on the basis of merit and no need for even closing the loop.
The second sign is that these companies have high talent density—a high proportion of strong people—at all levels. They serve as a talent source to both their sector as well as the broader market. Despite this churn, these companies have a strong pipeline of individuals for leadership roles. In our discussions, two contributing factors emerged as common themes: opportunity for personal growth at each stage and significant wealth creation opportunity, especially at senior levels.
Interestingly, we have found that the ex-employees of these companies maintain a strong connect with one another and with the company—in both formal and informal ways. The Asian Paints and Marico (both family-owned professional companies) alumni networks are as strong as Citibank, Unilever and IIM networks!
Thirdly, how the promoter family engages with talent is different and differentiated in these companies. There is genuine empowerment and delegation of authority to the management team. One of the CEOs we talked to described it as “receiving inputs, not instructions, and getting direction, not directives” and “most importantly, clarity on role and decision rights.” Another CEO described a penny-drop moment when the family disagreed with one of his decisions but agreed to support it fully in letter and spirit.
Finally, an important sign of these companies is the board composition. There are members of the family on the board, of course, but a significant proportion of its members are non-family, enjoy a strong reputation, and the board composition does change over time. When one talks to these board members, it is clear that they are not present as rubber stamps but as a true sounding board, as individuals who challenge both the family and the management, as needed. In short, the board should be a source of competitive advantage.
Making the transition from a ‘superman’ led venture to an institution takes time and conscious effort. It takes multiple years and sometimes even decades to achieve.
Here are three learnings from one of the authors who has travelled this path in building one of India’s most respected companies.
One: Consciously think of the role of the family, different family members and management.
Codify the same and then be scrupulous in living up to the credo. Clear articulation and consistent execution are critical.
Two: Disproportionately focus on attracting and retaining talent, and truly work in tandem with professionals as a team. Invest time and effort in creating an owner’s mindset in the professionals.
Third: Build and live the culture. It is critical to involve the broader organization in developing a culture and living it daily. The foundation of this culture is the tenet that the organization’s interest comes first—always.
In conclusion, it is critical to highlight that there are examples of both family member and professional run companies that generate significant value—and the signs outlined in this column apply to both.
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