Masterclass on Running a Family Business

Darius Teter: Last time on Grit & Growth, we explored managing a family business for success and succession with a mother-daughter duo who owned a Kenya based security company, Senaca East Africa, together with insights from Stanford Graduate School of Business lecturer, Peter Francis.

Peter Francis: Time and time again, you will hear of a family that gets into difficulty because a leader died suddenly, it wasn’t expected, it just happened. And the outcome of that leaves them adrift.

Darius Teter: Peter Francis is an expert in family businesses. He invests in them. He teaches a class on them here at Stanford, and he’s also the former CEO of a six generation family business.

Peter Francis: I have a very, very strongly held belief that leaders stay too long, not just in family businesses, but in all organizations. Now, it may sound like I don’t think they do a good job, but I think the leaders do things the way they do them. And by definition, organizations need change.

Darius Teter: I’m Darius Teter, and this is a masterclass by Grit and Growth with Stanford Graduate School of Business. The show where Africa and South Asia’s intrepid entrepreneurs share their trials and triumphs. Today, Peter Francis brings his knowledge and experience of the fundamental principles of running a family business. We learn about defining and understanding ownership models, how to make a success of generational transitions. And we hear Peter’s universal antidotes to resolve common pressure points. So without further ado over to you, Peter.

Peter Francis: My name is Peter Francis, and I am a member of a family that has a rather large family business, it’s in the sixth generation. I ran that company as a chairman CEO for 16 years, and I really enjoyed that effort, but I also felt that I didn’t want to overstay my welcome. So I retired from that. And currently I am investing in small businesses, which I’ve done for a long time just as an investor. And I also teach at Stanford at the business school. I teach a course on family business transitions called The Yin and Yang of Family Business Transitions. Prior to that, I had my own business and I enjoyed that. That was a company that I bought that was a family business. And now I am investing. I sit on boards, I teach, and I’m interested in a variety of nonprofits that I work with.

Darius Teter: That is really quite an incredible resume of experience. I love the title of your class too. How would you define a family run business?

Peter Francis: So there are, naturally, a number of different ways to do this, but as far as I’m concerned, there are two key things. The first is that a family needs to have sufficient strategic control, if you will, over that business, so that they can make key decisions such as who’s running the business, or have very, very strong input to those decisions. And then the second characteristic is they have to have the intent to take their family ownership and move it from one generation to another.

Darius Teter: Can we talk a little bit about advantages and disadvantages of being a family run business?

Peter Francis: Well, there’s a whole number of reasons why I think family businesses have some significant advantages, and it surprises people oftentimes to hear that family businesses actually perform better than their public counterparts. In fact, some work that I’ve seen says the return on assets annually in the United States is 6.65% higher. Similarly, in Europe, eight to 16% higher ROE. And it strikes me that there’s a number of good reasons why that can be the case. For me, there’s really just four really important things. The first is what I call patient capital. The second is speed of decision-making.

The third is the ability to pursue unconventional strategies. And the fourth is values driven, pride of ownership, if you will. The first, patient capital, to touch on this, is really important. I think that the average, or the median tenure of a CEO in the Fortune 500, S&P 500, is something around the range of five years. And if you think about it, the incentives for an individual who’s in that position therefore are on a very short timeframe, and yet investments often pay off over the long term. So what creates the incentive to pursue those things where you have to be patient about the capital, but you can end up with higher annual returns because of it?

So the second one, speed, oftentimes people think of family businesses potentially being slow. However, that doesn’t have to be. Indeed, they can make decisions extraordinarily quickly because they may have a smaller shareholder base, it could be only a couple of people. And so they could make a decision where they want shareholder input and it can be very, very fast. The third, unconventional strategies, I think is really interesting. You’ll find many family businesses over time, end up in what I’m going to call a conglomerate, a multi-business structure, because they can mitigate some risks by investing in other places. Generally speaking, if you were running a big oil and gas company, and you went out to your shareholders and said, oh, I’m just going to go out and buy companies from the market. Your shareholders would probably not be very happy with you, but in a family business, you have an opportunity to make unconventional decisions like that. And then the final one, values driven I don’t want to overlook because it is the case that, and it doesn’t have to be this way, but you can create some incredibly strong values that actually pay off.

Darius Teter: So you’ve done a great job listing four big buckets of advantages to family businesses, not automatic, you have to work for those advantages. And yet there’s actually a pretty high family business mortality rate across generations. From the research I’ve read, something like only 30% of family businesses survive the transition from the first to the second generation, and 9% or so survive the transition from the second to third generation. Why are those transitions so difficult?

Peter Francis: Basically family businesses, only 30% make it from one generation to another. You keep doing that math. And, of course, by the time you get to generation four and five, it’s down into 0.8%. So then I did some research and it showed that the average life of a public company, this is in the United States, this was in the S&P 500, is well less than 20 years. And a generation, I would say, in a family is something 20 years, 30 years, when do they have their kids? So actually family businesses do better than public companies. Now you need to understand that doesn’t mean that these companies necessarily go bankrupt and go away. It’s just that they may get sold, or broken up, or moved into some other ownership form. And so, while it’s frequently that statistic that you talked about gets talked about, and it implies that somehow there’s something wrong with the structure, actually the data would suggest that family businesses do better on that front.

Darius Teter: That’s interesting. So what are some of the challenges of the transition from the first of the second generation?

Peter Francis: So while the family businesses themselves and the cultures are very different all over the world, the issues that show up in generation transitions actually are very, very similar. It really comes down to the fact that we’re talking about human beings here. And to me, that’s the good news, because it means we can learn from other people who have done it well. For instance, one of the top ones in generation one to two is the leader transition. He or she doesn’t desire to go. They really don’t know what else they’ll do. And to that end, the business is totally reliant on that person, and that person is essentially totally reliant on that business. Oftentimes there’s no specific plan for succession, or process for that. Haven’t given that any thought, depending on the circumstances there can be estate planning issues, or there are tax effects in some places that may put pressure on generation one to two transitions. Certainly as you go from one generation to another, you’re diluting wealth, because you have more people involved.

In those first one to two generations, nepotism, or the perception of nepotism can be an issue. When the person goes to work for the company, people who are working there assume they got the job because of his or her name. And so it is actually a challenge for a family member who’s going into a company to be able to get past that in some cases. There’s often a belief that fair means equal. On a variety of fronts, whether it’s pay, or power, or prestige, oftentimes there’s a lack of transparency about what’s going on in the business. Sometimes it’s couched in, well, people won’t understand the numbers or whatever. Frequently, there’s a lack of discipline, lack of professionalism. There’s really very little oversight, perhaps not many policies and procedures. There’s oftentimes weak training and development, the erosion of entrepreneurial culture that can happen. Generation one to generation two, it’s a worry that people have. And then the final one is a variety of family conflicts, rivalry, rebellion, parent-child relationship, anxiety, all that kind of stuff that invariably shows up in family businesses, but needs to be dealt with.

Darius Teter: You said you were, I think, 16 years as the CEO of a six generation family business. I want to hear how you felt as you contemplated letting go.

Peter Francis: So my experience there may be slightly different from others. I have a very, very strongly held belief that leaders stay too long, not just in family businesses, but in all organizations. Now it may sound like I don’t think they do a good job, but I think the leaders do things the way they do them. And by definition, organizations need change. So to that end, I basically felt that a reasonable period of time to run and make significant changes in a rather large corporation was maybe no less than seven years, maybe 10, 12, 15 years, but not 20 and 25. And so I told my board five years before I was going to retire that I was going to retire in five years. And I actually ended up doing exactly that. And I got out of the way completely, meaning I gave up my chairman’s title, and I wasn’t on the board, and I wasn’t in family governance. I got out of the way completely, but that’s not the norm. I just believe, in my view, it’s the right thing to do for the organization, whether it’s a family business or any other business.

I would say just as an aside, the model where the prior CEO becomes the chair, I think it is flawed. It’s flawed because the new person comes into this meeting as the new CEO and perhaps suggests doing something, and everybody looks at the prior chair CEO and says, well, what do you think? It’s an impossible situation. The premise behind it is, oh, it’ll create continuity. The truth is, if you’ve picked a good CEO, he, or she’s more than capable of running the company. And they do.

Darius Teter: That is fascinating. It’s funny. I’ve almost taken it, when I read the business news as an article of faith, that when you leave your CEO position, you go to the board and you hang out there for another three or four years, however many years, in some ways, as you said, it doesn’t also address the stagnation problem. It maybe even stifles new ideas and opportunities to change strategy.

Peter Francis: I think it does that even if the person has the best of intentions, because then as the CEO, you basically don’t want to insult anybody by suggesting a major change. So it slows things down. So I would suggest that the worst case, of course, is the person still wants to run the place. But the best case is the person really wants to be supportive. And yet, if you think about it, it’s really hard for the new person to say, you know what? What we’ve been doing for the last 20 years I don’t want to do anymore. It’s tough.

Darius Teter: So many of our listeners work in family businesses with complex relationships that might be mother, daughter, boss, subordinate siblings. Can you talk a little bit about best practices?

Peter Francis: I like to say that for family members working in the company, it’s an opportunity for them, but it’s not their right to keep the job. So I would give a family member an opportunity to come work in the company, and that opportunity, I don’t want to say it would be in front of a non-family member per se, but they’d have their chance. And so the second half of this is, I think organizations need to have effective people development programs. And that includes feedback. Once a family member is in the business, then they’re like any other employee, and they’re going through the process like any other employee.

We have a youngish family member who works in our business, who actually said exactly that at one point to family members. We were having a family meeting and there were a hundred people sitting around a circle, and you could step into the middle of the circle and say whatever you wanted. And this individual made this impassioned statement that, look, I’m working in the business. If for any reason I lose my job, or I don’t get promoted or something, that’s on me. And I don’t want anybody in this family to think that somehow or other, I should have extra special treatment over anyone else. And it was such a powerful statement.

Darius Teter: And how do you enshrine that, because there will be other employees in that company who are not family members, and will be watching very carefully to see how everyone is treated? What are your rights and responsibilities as a family member in the business, whether or not you’re an owner? How do you enshrine that and make it transparent?

Peter Francis: In the end, you’re talking about what kind of a culture do you create? And that culture is both in the business, but also in the family. And those two things come from a variety of sources, but in the business, I would say, it’s not what you say with your mouth, it’s what you do with your feet. And so early on, family leadership needs to make it crystal clear that that’s the way it’s going to operate, and then they need to operate that way. And I will tell you what you do will outweigh what you say.

The second half of that is in the family itself. How do you ensure that the family has this feeling? And one of the things that you can do, and one of the, what I call my universal antidotes, one of those is education. And I don’t mean formal education, which is great too, but I mean, it is an opportunity in a family business to educate your family members in a variety of things, not just make them great potential employees, but also prepare them to be really great potential shareholders. And so that’s something that you can do as the family gets bigger, it can get more complex if you will, but it can be done early on.

Darius Teter: I think there’s a, sometimes a simplistic view about how family members participate in a family business, but actually there are some pretty clear categories. Could you speak to that briefly?

Peter Francis: I think in the simplest form, you have what you might call active owners and you have passive owners, just generally, but in the different categories, say an active category, basically John Ward, who’s been a terrific researcher in this area and was so helpful to our family early on. And he basically identified three categories of active owner. There are operating active owners. That’s people literally that are in the business, working in the business. There’s governing active owners. Those are clearly people who are overseeing things like on a board. And then there are people who just remain active. And by that I mean, they read the information that comes out from the company. They ask questions, they’re interested. And so while they may not be involved directly in the business, they show their interest through basically how they pursue their understanding of the business.

On the next category, passive owners, there’s really two of those he identified, one are investing owners. These are literally people who think of this as a financial investment, pure and simple. And then there are some truly that are just completely passive. They don’t pay any attention to the investment at all, or to the business at all. He makes the comment, and I think he’s right, that if the majority of the shareholders aren’t in one of those three active categories, then it’s unlikely for the business to stay family owned. If your only interest, literally, is as an investment, or you have no interest at all, then likely you’re not going to be staying an owner of the business because you will want to diversify your ownership, things like that, if you’re the investor, and on the passive, you just don’t care.

Darius Teter: You also talk in your lectures at Stanford about the difference between family ownership, directorship and management. I guess that crosses over into what we’ve just covered.

Peter Francis: It does. And I think it’s an extraordinarily important framework that has been around since the 1980s. I think it was John Davis and Tagiuri, they came up with a concept of what they call the Three-Circle Model. The basic concept here is that there are three systems that are interacting in a family business. One system is the business itself. One system is the family system. And the third is the ownership system. Now, if you think about it, if you were an entrepreneur and solo, unmarried, no family, and you start a business, you are the business, you are the family, and you are the owner, that’s it. But let’s say you end up getting married and have children. Then suddenly there is a family that may be working in the business and maybe owners, but maybe they’re not. So those three circles are separating. And if you look at that, it’s a Venn diagram with seven places where people could be and they have different perspectives.

Now, as a family business gets bigger, the likelihood is that most people will be in that family circle, less people in the business, and maybe people are owners, maybe they’re not. So for example, are spouses permitted to have shares in your family business? Some yes, some no. If they’re not, then they’re in the family, but they’re not in the ownership system. And so, one of the key things to be thinking about is where are we having this conversation? Is it truly a business question? Is it an owner’s question, or is it a family question? And educating the family about those different discussions and the different governance structures in those different systems becomes a really important part of developing themselves over time.

Darius Teter: This is so fascinating. I think we’re right at the crux of issues that I have seen in a lot of family businesses, people not being clear which circle they’re in, not understanding that there are three different circles. How do I think through that as an owner, as my kids are growing up and I want them to be engaged in the business, or maybe some of them, how do I think through organizing my expanding circles?

Peter Francis: I’ve asked myself, are there any universal antidotes to the issues that show up in family businesses? And, of course, there’s never truly a universal antidote, but then I go on and say, here’s three that I think are interesting. The first is education. The second is transparency. And the third is communication. When I speak of education, it’s so powerful for family members and owners to have a language to use so that they can communicate. So for example, if you’re having a conversation about the business and that conversation, if you will, was at home, it might be the case if people were educated about the fact that things get muddied up, might say, you know what? We’re home. We should be wearing our family hat, not our business hat. And people will respect that.

As it relates to transparency, the same thing, the fastest way, it seems to me, to upset somebody is to make them think that you’re keeping something from them, that they believe they should know. And so creating that sense of transparency I think is important. And so we actually teach that. And then finally communication. And by that, I don’t mean just communicating, but also learning how to communicate. We can be trained to handle difficult conversations more effectively. We can learn how to do that. And so that ability to communicate more effectively is a muscle that we can strengthen in the family. And so that gives people a chance to be better at this as they go forward.

Darius Teter: So I think what’s so fascinating to me about what you’re saying is that, to understand the role that education has in this, requires you to understand that different conversations are in different virtual rooms.

Peter Francis: There is a different model that’s used, and I don’t want to be too academic, but this particular model, it was developed by the Banyan Group out of Boston. And they do think of it as rooms. So they think of a house, if you will. And there’s an owner’s room where certain things happen. There’s a boardroom where certain things happen. And then there’s a management room. So you’ve got the business with its board and its owners. That is a normal hierarchy within a business. And then they take the family room and they lay it alongside all three of those rooms. And so you can imagine that if you started out as a founder in a business, and there were none of those structures, there was no owner’s room, there was no boardroom, there wasn’t really a management room, and you came home and in the kitchen, you had this discussion, there’s only a one room house. Things can get pretty messy.

Darius Teter: So what should we be discussing around the family dinner table? Or maybe I should ask, what should we not be discussing around the family dinner table?

Peter Francis: First thing they should be discussing is who’s going to do the dishes, and that should be shared as far as I’m concerned.

Darius Teter: Amen.

Peter Francis: The person who cooks shouldn’t have to do the dishes.

Darius Teter: Had that fight yesterday?

Peter Francis: So, clearly I don’t want to be pedantic about this if it’s early, early days, and it’s you and your spouse, and there’s no kids, and you’re both working in the business and you’re home for dinner and you’re talking about it, maybe you shouldn’t, but I’m not sure that, that’s going to stop. But I think in principle, the notion that you actually bring business problems home and try to solve them there, strikes me as inherently flawed. And so you wouldn’t want to have those kinds of discussions in the family room. I would say that there’s a couple of ways to think about it. There could also be a missing room. Many, many companies don’t have boards, and do they need them right away? No, maybe not. But at some point as they get bigger, they probably do. Or you can have the room, but it’s messy. It’s not well organized to have the appropriate kinds of decisions made. Because in the end, when I say room, it’s also a system.

And at some level, there’s governance, which is just a fancy way of saying way of making decisions. And that can be well and clear and well laid out, or it can be messy and not well laid out. So as families become bigger and get more complex, making sure that things are clear, people that have the right language, that’s really what’s important.

Darius Teter: You touched on this question of boards, I’d like to just drill down there a little bit. When is a company ready for a board? And what are some best practices, corporate governance best practices for family businesses?

Peter Francis: I am a fairly strong advocate for boards, and I think they add tremendous value. And when I think of them, I don’t mean boards just with shareholders/ family members. I mean, with independent outside directors. However, that only works if the people that basically have the power want that to happen, and want to get the benefit. So it costs money to have a board. And I like to think of it just as an investment, and I want to expect a return on investment. And so it’s important to make sure that you have, and you go out and get good directors, but it’s equally important that you listen to them. And that is a really hard first step to take. So it is not at all atypical for a family business not to have a board. And when they do their first board, they oftentimes will put a couple of family members or shareholders on the board. And then they often will go to friends to be board members, because they trust them.

And I totally understand that, there’s a real concern, oh gosh, I let an independent director in, he or she’s going to take control. It’s going to be awful. And I think that’s a reasonable first step. Think of it as a board of advisors, but not a fiduciary board. I would say that at some point creating a fiduciary board, especially as the businesses get somewhat larger, is a hugely powerful step. And I would encourage people to consider the possibility of having a board, let’s just hypothetically say that only one person who’s actually in management, I think should be on the board. That’s typically the CEO. And then maybe there’s two or three, I would suggest at least three independent outside directors.

I think it’s incredibly important to pick those people based on the needs of the business. And this is where the power of a board comes. It’s where an independent person will actually ask questions, will be willing to push back. The Business Roundtable I think had a terrific definition of a good director. And they said, this is a quote, “Effective directors maintain an attitude of constructive skepticism. They ask incisive probing questions and require accurate, honest answers. They act with integrity and diligence, and they demonstrate a commitment to the corporation, its business plans and long-term shareholder value.” That’s a pretty good definition of a director. If you could get two or three or four independent directors that fit that, and you listened to them, it’s going to make your business better. It’s going to be worth it. And the business will make more money.

Darius Teter: So as a leader of the company, you’re bringing on independent board members because they’re bringing some specific domain expertise. So it’s actually very strategic as well.

Peter Francis: Very, in fact, I don’t want to get too organized about this, but there does come a time, and maybe it’s right up front, where you actually talk about what are the areas where you need support in your business, for instance, are there particular geographies, are there particular markets, are there particular operational things? And then you actually start to fill that in so that you’d have the strongest board that you can possibly have. And I would tie this to the notion of term limits.

Again, I tend to be perhaps a little bit on one side in this, but I actually think term limits are critically important for organizations. And it isn’t, again, that people are deadwood, but it is that they do things the way they do them. And to think that you can’t find somebody else who has something valuable for your corporation, I think it’s just wrong. And it seems unfortunate, but it does come down to culture. And early on, when it’s the founder, she or he has to feel this passionately. They have to believe they really want that accountability and experience, and that it’s going to pay off, it’s worth it.

Darius Teter: So I’m an owner, I want my business to survive for my children. I want it to thrive. Where do I go for resources to think through how to design and plan that succession process to be successful?

Peter Francis: What I would say is that in this generation one to two transition, which is so critical, ultimately the founder is the key. It is, I think, very common that certain human emotions rule the day. So denial and conflict avoidance, for example, they’re there in spades that we might need something different. Secrecy, distrust. So when thinking about how you get started, the founder is the key and he, or she can use the universal antidotes to begin to move things along. And I think starting with a vision and agreeing on some structure and process is a good way to go. And the vision could be as simple, we really do want this to be a family business that goes through the generations. And then I would say, get help and get educated. Now there’s help available in all sorts of places. I do think there’s a tremendous role to be played by an outside voice. And that is because there are some very emotional aspects to it. And how do you get past those?

There are specific family business consultants who can be extremely helpful. On the other hand, depending on the size of the business, there may or may not be the wherewithal to do that. One thing I would say is critically important is that somebody at least needs to think ahead. And arguably in the beginning, if the founder isn’t really thinking ahead, then it’s hard to get started. So how do you get started if the founder isn’t willing to move forward? Much, much harder. Some thoughts here are a group of family members who are interested could begin to meet without the founder, not in secret, but just there to get going. And they invited an advisor to that and they begin to learn. And then that they begin to talk about, they’re talking about it, back around that kitchen table, if you will. And perhaps the founder begins to get interested.

Possibly you could discuss it with somebody who the founder admires. This is where business groups can help. And similarly, you can meet with other families. There’s the International Family Business Network, for example, that puts on events and there are others. And then finally, you could go to a course or a conference, a little bit more of a commitment, but it’s also a way to begin the language building around, how do we talk about this?

Darius Teter: So the question I had for you is, what have I neglected to ask you that I should’ve asked?

Peter Francis: There are some interesting ownership concepts that we’ve touched on, but I think that it might be worth emphasizing. One is the effect of unintended consequences. That’s important whether it’s a family business or not, but as it relates to ownership, that’s really important. And I don’t want to raise an unhappy concept, but the fact of the matter is, time and time again, you will hear of a family that gets into difficulty because a leader died suddenly, it wasn’t expected, it just happened. And the outcome of that leaves them adrift. And so that’s just one example. It can be all kinds of unintended consequences, but what it does do is it certainly puts some focus on making sure that we think ahead. The requirement for active owners, which we talked about earlier, I think is important. If people just aren’t interested, then it’s not going to stay a family business, it’s just not. That doesn’t mean they have to run the business, and it doesn’t mean they have to be on the board, but they have to be interested.

I want to reiterate the need for ownership, education. And there’s four particular financial goals that I think it’s important for the owners of the business to have some thought about, and be able to share that as thoughts with management and the board. Those four are: risk—how much risk do we want to take with our business? How much growth do we want to pursue? What level of profitability do we want, and what sort of liquidity do we need as a family? And those, in order to have a clear discussion, your family has to be reasonably well-educated about the implications of all that.

Second ownership concept, which I think is really powerful for me anyway, is incorporated in the word stewardship. Think of what you can do as a family business if you have strong values that you want to incorporate in the way you run your business? This ability to steward this and have it go from one generation to another can be super powerful. So in my own family, for example, we’re very, very environmentally conscious, and that’s built into the business, very much care about employees, and that’s built into the business. And so there’s a lot of things that can be done along those lines. And I think it’s really, really an important aspect of it.

Darius Teter: And that brings us to the end of today’s Masterclass. I want to thank Peter Francis for sharing his knowledge and experience with us once more. Throughout our discussion of these useful strategies and tactics, education, preparation, and communication emerged as the foundations for effective family business management. The leader has a pivotal role to play in defining the roles of family business members, establishing a governance structure and beginning the transition process. And this last point is perhaps the most important. The leader has to consider when it is time for them to go, not with fear, but with confidence that they have built a solid foundation for the future. The culture of a family business is built by every active member with the will to be involved. And they build a legacy of values to be handed on through the generations.

Peter Francis: As I thought of my own family, I really wanted to try to combine what I would call the participative culture and a professional culture. And clearly professional you think of public companies and things like that, but I find them too oriented toward the present. And I really wanted to build into the present and into the future. And I think building a participative culture where there’s more group decision-making, harmonizing, proactive, I think that can do that.

Darius Teter: This has been a Masterclass from Grit and Growth with Stanford Graduate School of Business. And I’m your host Darius Teter. If you want to find out more about how Stanford Graduate School of Business is partnering with entrepreneurs throughout Africa and South Asia, visit seed.stanford.edu/podcast. If you liked this episode, don’t forget to hit follow and share it with a friend. Grit and Growth is a podcast by Stanford Seed. Laurie Fuller researched and developed content for this episode with additional research by Jeff Prickett. David Rosenzweig is our production coordinator, and our executive producer is Tiffany Steeves. With writing and production from Isobel Pollard and sound design and mixing by Alex Bennett at Lower Street Media. Thanks for joining us. We’ll see you next time.