The Family Affair: Making founder-led businesses work

Episode #76 The Family Affair: Making founder-led businesses work

Hey there and welcome to episode 76 of the No Bullsh!t Leadership podcast. This week’s episode, the Family Affair: Making Founder-led Businesses Work. There are lots of different ownership structures we come across in the world of business and family owned businesses are extremely common. Some of these relatively small and some are massive enterprises. We had a question a while back from one of our listeners, Owen, who asked, “Do you have any advice for a CEO going into a family run company?” Now as usual, I’m going to expand on this a little to take into account a few scenarios. So I’ll start by outlining the context of founder-led businesses and how they differ from other business ownership structures. We’ll talk about what to watch out for if you go into a founder led business, and I’ll finish with some tips for navigating these waters, if you’re the person brought in to take over a family run business when the founder of the sells, retires or realises that she no longer has the capability to lead the business through its next phase of growth. So let’s get into it.

Let’s talk ownership structures. The ownership structure of an entity makes a big difference. Very different cultures evolve in different ownership structures and as part of a management team, CEO or below it can be really tricky. I want to take a quick look at a few of the more common structures just to give you a feel for some of these nuances. So let’s start by looking at the first type, the family business. It is famously said that the first generation creates the wealth, the second generation preserves the wealth, and the third generation destroys the wealth. Now this isn’t just a glib one-liner – it does have foundations in social psychology. So the first generation, the founders of the business typically have the drive, the work ethic, and a strong connection with humble beginnings to drive the success of the business. Successful founders that grow significant businesses are committed in a way that most people on the planet are not – and that’s why there’s so few of them.

Never underestimate how difficult it is to achieve what these founders achieve. To start with a blank sheet of paper and take an idea, a product or a service to market and to build a going concern is tough enough. But to build something of real substance and wealth to pass onto the next generation is a phenomenal achievement. And in case you haven’t worked this out already, there is no luck involved. Well, no more for them than for those who are less successful anyway.

The second generation typically steps into the business from a different vantage point. They have vague recollections of the struggle and the hard work that their parents went through, but not in the same way. They’re generally well educated because their parents do that for them. They’ve often acquired friends with some genuine money and lifestyles to match through their first rate educations, who they feel obliged to keep up with. They often see the original income stream from the assets split between a number of siblings, and some of them work to preserve this, while others cash out. And their parents, the original founders, need an income stream to keep them in retirement. So for the second generation, often simply preserving the wealth is no mean feat.

The third generation is another layer again removed from the struggle, the sacrifice and the hard work. They’ve often become quite entitled on the way through, they have consolidated the friendships with wealthy friends and families, and they often see the family business as a magic pudding which will continue to produce healthy dividends regardless of whether or not they decide to continue the legacy of their grandparents, diversify into riskier ventures like purchasing a string of nightclubs, or to opt out altogether.

Now, whereas this is clearly a rash generalisation, it does explain some of the differences and because of that, it’s important to know what you’re dealing with if you’re an outsider looking to join a family-run business, just as it is to be aware of some of the potential pitfalls if you’re in one of those generational groups I spoke about.

The second type of structure I just want to talk about briefly is an extension of the first, a common move for founders as they look to expand is to seek capital on the stock markets of the world – so, to list the company as we call it. This enables them to convert some of their equity to cash while still holding a sizeable portion of the business in family hands. It also provides capital for further business expansion. Now, this can become a little tricky. The corporate governance required, once a business moves to become a publicly traded stock, is an order of magnitude greater than a privately owned business. Many founders struggle to come to terms with this, and continue to use the company as an extension of the own private affairs, which is neither legal, nor in the best interest of the other shareholders.

However, this has been done extremely successfully by many of the great businesses that had their origins in privately owned founder businesses.

The third type is the broader publicly listed company. So let’s focus briefly on their characteristics. They have multiple owners, most of whom as a management team, you don’t know. Often there’s a mixture of large institutional shareholders and then what we call “Mums and Dads” shareholders. These are often the most rigorous in terms of the demands of the owners to run. For a start, capital will desert you much faster in a listed company if anything goes wrong. You have to deal with continuous disclosure obligations to notify markets of any issues or events that could materially affect the valuation of the shares. This can be pretty tricky to navigate, knowing what to tell the market, when, is much more complex than it might seem. You live under the constant scrutiny of investment analysts and there is an enormous short term pressure to meet the quarterly earnings guidance, which can often take the focus away from investing in the creation of longterm value.

Personal exposure for directors, at least in Australia, to any missteps of the business that are considered to have been negligent or not to have been in the best interests of the shareholders are extremely onerous. This is a whole different kettle of fish to a non-listed entity.

Another type of privately owned company is those owned by private equity or PE, and these have become much more prevalent in the last 30 plus years. PE firms tend to invest in a portfolio of businesses that they acquire for a discounted price – often when the valuation is depressed or the business has been poorly managed. It used to be the case that PE firms would buy a company at the bottom, with the sole intention of improving the short term metrics and selling for stag profit within two to three years. Longterm value destruction was almost guaranteed, and the next owner generally had a pretty tough time of it – but this has shifted massively in the last five plus years to the point where PE offers some of the most favourable ownership conditions.

They look after management, they invest in the business growth and longterm results, and they avoid much of the conflict that comes from more elaborate structures where for example, multiple owners with differing expectations, slug it out, limiting the value that can be created. Finally, I want to mention a structure that’s close to my heart – the government owned corporation. Now, there are commercial and non-commercial businesses that are owned by governments, and the dynamics here can be really complex. They generally have an independent board and the owners are supposed to be at arms-length from the board, but this is not often the case. Governments are generally excellent owners of businesses that provide social services. So think passenger rail or electricity distribution infrastructure. They require large capital investments upfront to provide an essential service, and they’re investments that at the outset would be the too risky or capital-intensive for private-listed firms to invest in. The government, however, is usually well positioned to understand what’s required and to subsidise that through social redistribution of wealth from taxpayers.

Now having said that, my view is that no commercial assets should be held by governments. As I said, some types of businesses lend themselves to government ownership and government are excellent owners of those. But for commercial businesses, they can place a weighting on social outcomes that is disproportionate to the market in which the firm operates. So this can expose taxpayers to commercial risk and it can crowd out private investment in markets. So a classic example in Australia right now is the proposed Snowy Hydro expansion, that will cost many billions of dollars – and I’d be surprised if they got out of it under 10 billion when all is said and done. These investments are what I like to call a victimless crime because the people who provide the investment capital, i.e., the taxpayers, have no visibility of the commercial viability or the outcomes from projects of these types. Now, I’m not saying that this particular investment isn’t warranted, it may well be, but governments investing in commercial assets undoubtedly distorts the market.

Let’s go back to founder-led businesses and talk a little bit about what to watch out for. Now, I’ve come into contact with many founder-led businesses and have a range of experiences. Some have been through close colleagues of mine who’ve gone in as the CEO when the founder steps out or back. I also have a range of clients in founder-led businesses, so here are a few watches.

The first thing is many founders reach a point where they realise they are out of their depth. Very commonly as the business grows, the ability of the founder to manage it doesn’t. They rely on the same things that made the business successful in the first place. So their passion for the product or service, their personal tenacity, work ethic and resilience, their individual brilliance and their technical knowledge and knowhow of how the company operates. But the business grows to a point where they have a bunch of people who don’t do things the way they do or who don’t have the same level of commitment.

They struggle to let go of the things that made them successful, and they don’t know how to lead. They can feel the business slipping from their grasp. So, if you’re in a founder led business, you may have observed this type of scenario. The next thing you might observe is that founders often believe that they want to change their business, but they don’t really. Most commonly, I see good leaders going into these businesses to make a difference. They want to bring better governance, greater efficiencies, and a more robust strategy and so forth. Now the founders have realised they need a stronger management team with broader experience of businesses at scale. But when push comes to shove, they don’t really want that at all. It’s their baby and no one wants to hear that they have an ugly baby. It’s actually quite a rare founder who can bring an outside management team in without constraining them and interfering in how they think the business needs to change.

So you know, when push comes to shove, when the old and bold start complaining, who’s the founder going to support – them, or you? The next thing is about power dynamics and influence. Founders who retain even a passing interest in how the business is handed over, so a minority shareholding or even just a board seat, can exert disproportionate influence. They have already a lot of earned respect, which they absolutely should have, but it makes it very difficult to build a critical mass for change, if the founder’s in the background trying to preserve the status quo. Now having said that, founder-led businesses are not always like this and I want to mention one in particular that I had the absolute pleasure of working with a few years ago.

This was the Lemos shipping company. Run from Greece and London by brothers Filippos and Andonis Lemos. Now they’re fifth generation of the family shipping business. They are growing, diversifying and consolidating a wildly successful legacy, Built over generations. They demonstrate incredibly strong values. The problems of latter generations that I mentioned earlier, simply don’t apply.

They respect tradition, reputation, trusting partnerships, management, prudence and continuous learning. And they’re building on a legacy long after many third-generations have frittered away the wealth. Now, these are the types of people in founded-led businesses that I love doing business with and I learned a lot from the Lemos brothers in my very brief exposure to them and their team.

Let’s finish with some tips for navigating the choppy waters of a family business if you go in to run it. Now to be clear, my direct experience of family businesses extends no further than the year or two I’ve been in this business with my daughter Emma as joint founders. However, I’ve polled a bunch of my colleagues with deep firsthand experience for their views to supplement my own arms-length observations. I’ve got six suggestions here and they’ll be available as a free downloadable from the Your CEO Mentor website, www.yourceomentor.com/episode76.

The first thing is to respect the history. When you go into a family-run business, don’t change things too quickly. Look at people’s contributions over time. It doesn’t mean they can take the business forward, but they’ve helped to get it to where it is now and make sure you genuinely marvel at the success the business has had to date.

Number two, agree on what’s important with the owner before you get started. Now you have to agree this right up front and it has to be around the outcomes required. If not, you have absolutely nothing to fall back on, if the founder later questions your approach. Find a way to test their commitment to the outcomes, and we’ll have more in the shortly. But you need to agree on your level of autonomy and what decisions the founder should or will be involved in.

Number three, set clear boundaries, and this starts with role definition and accountabilities, but if you’re dealing directly with the founder-owner, make it clear upfront what you need from them to be successful. They need to support you when the complaints start to pour in – like any boss, you don’t want them coming in over the top of you on your decision rights. Number four, understand and believe that the people who built the house can’t renovate it.

Now, I did a podcast episode last June called “The People Who Built The House Can’t Renovate It” – I think it’s episode 46 – it’s worth you going back and having listen to that because it really applies here, but the people you come across in a family-run business have probably never been given the same sort of direction that you would give them. If this is all they know, they’re unlikely to get why there is a need to change, so you’ve got to give them a chance, but don’t mistake their recalcitrance for anything other than what it is. They need a chance to come on board, but don’t wait indefinitely. This should never override the setting of standards that you need to enforce in order to make improvements.

Number five, treat the long-termers with compassion. Reward their loyalty. Use their corporate memory and technical knowledge to further the business, but don’t be afraid to move them on to more suitable roles if you need to. You’ve got to bring in the right mix of new people with different experience and capability sets. Just remember, your success depends on how well you can blend the old and the new – culture, capability and skills.

Finally, number six, just because it’s a family business doesn’t mean you have to run it like a family. Have you ever heard the expression you can’t choose your family? Well, you can and you must choose your employees – that is if you want the business to perform. Now in a family we tend to overlook and excuse many things, but doing that in a business is highly destructive. The family culture is not necessarily desirable here, so caring for your people like a family case for its members is probably a good thing. But on the other hand, allowing any old standard for people because they happen to be part of a family is absolutely not.

I’ve had founders as mentoring clients who say to me, “Marty, I don’t want to lose the family culture as we grow.” I actually struggle to get their heads around my advice that the family culture is likely to be one of the greatest inhibitors of performance, and it’s what they most need to change.

Alright, so that brings us to the end of episode 76. Thanks so much for joining us, and remember at Your CEO Mentor, our purpose is to improve the quality of leaders globally, so please spread the word about the No Bullsh!t Leadership podcast in your leadership community. I look forward to next week’s episode, “Can Your Team Handle The Pressure?”

Until then, I know you’ll take every opportunity that you can to be a No Bullsh!t Leader.