How to Save the Family Business

reprinted with permission of Peter F. Drucker

Management books and courses deal almost entirely with the publicly owned and professionally managed company. Yet the majority of businesses everywhere–including the U.S.–are owned and run by family members. They even include some of the world’s largest companies.

If the family-managed business is to survive, let alone prosper, it must stringently observe the following rules:

  • Family members working in the business must be at least as able and hard-working as any unrelated employee. In a family-managed company, relatives are always “top management,” whatever their official job or title. On Saturday evenings they sit at the boss’s dinner table and call him “Dad” or “Uncle.” Mediocre or lazy family members are therefore–rightly–resented by non-family co-workers, and respect for top management and the business as a whole rapidly erodes. Capable non-family people will simply not stay, and the ones who do soon become courtiers and toadies. It is much cheaper to pay a lazy nephew not to come to work than to keep him on the payroll. DuPont, controlled and managed by family members from its founding in 1802 until professional management took over in the mid-1970s, grew into the world’s largest chemical company. It prospered as a family business because it faced up to this problem. All male duPonts were entitled to an entry-level job in the company, but five or six years later their performance was carefully reviewed by four or five family seniors. If this review concluded that the young family member was not likely to be top management material 10 years later, he was eased out.
  • Family-managed businesses, except perhaps for the smallest ones, increasingly need key staff positions with non-family professionals. The demands for knowledge and expertise–whether in manufacturing, marketing, finance, research, or human resource management–have become far too great to be satisfied by family members alone, no matter how competent they may be. Once hired, these non-family professionals have to have “full citizenship” in the firm. Otherwise they simply will not stay.

The first people, perhaps, to realize this were the Rothschilds, who—two centuries after a coin dealer began to send out his sons to establish banks in Europe’s capitals–are still among the world’s premier private bankers. Until World War II, they admitted only family members to partnerships in any of their banks. But during the 19th and early 20th centuries, whenever a non-family general manager reached age 45, he was given a huge severance payment and set up in his own banking firm.

The duPonts, around 1920, found an even better method. While not appointed to top management jobs, non-family members in key positions were given “phantom stock”–participation in profits and capital gains without diluting family ownership and control, a still popular solution.

No matter how many family members are in the company’s management, and how effective they are, one top job must be filled by a non-relative. Typically, this is either the financial executive or the head of research—the two positions in which technical qualifications are most important. But I also know successful companies in which this outsider heads marketing or personnel. And while the CEO of Levi Strauss is a family member and a descendant of the founder of this 144-year-old company, the president and chief operating officer is a non-family professional. Such an outsider can be objective and does not have to worry about the reactions of relatives, whether in the business or not.

I met my first “outsider-insider” almost 60 years ago, the chief financial officer of a very large family-managed business in Britain. Though he was on the closest terms of friendship with his family-member colleagues, he never attended a family party or family wedding. He did not even play golf where the family played. “The only family affairs I attend,” he once said to me, “are funerals. But I chair the monthly top-management meeting.”

Before the situation becomes acute, the issue of management succession would be entrusted to someone neither part of the family nor part of the business. Even the family-managed business that observes the first three rules tends to get into trouble–and often breaks up–over management successions. It is then that what the business needs and what family members want collide head on.

Typical are the two brothers who built a successful manufacturing business, working together for 25 years. Now reaching retirement age, each pushes his own son to head the company. The brothers become adversaries and eventually decide to sell out. Or take the case of the widow of one of the founders of a company. To save her daughter’s marriage, she pushes her moderately endowed son-in-law as the next CEO and successor to her aging brother-in-law. Anyone who has work with family-managed companies could add to this list.

There is only one solution: Entrust the settlement of the succession issue to an outsider. This role was played successfully by a CPA who was the outside auditor of a medium-sized food retailer since its founding 20 years earlier. A professor who for 10 years had been scientific advisor to a fair-sized high-tech company saved both it and its parent corporation by persuading two brothers and two cousins–and the wives of all four—to accept the ablest member of the next generation as the future CEO.

But it is usually much too late to bring in the outsider when the succession problem becomes acute. Family members have taken positions and have committed elves to this or that candidate. Moreover, succession planning needs to be integrated with financial tax planning. Family-managed businesses, therefore, should try to find the right outside arbitrator long before the decision itself has to be made.

Sixth—or seventh-generation family businesses like Levi Strauss and the Rothschild banks are quite rare. The biggest family-managed business today, Italy’s Fiat, is run by the third-generation of Agnellis, now in their 60s and 70s. Few people in the company, I am told, expect it to be family managed 20 years hence.

The fourth generation of a family owning a successful business is sufficiently well off, as a rule, for the ablest members to want to pursue their own interests and careers rather than dedicate themselves to the business. Also, by that time there are usually so many family members that ownership has become splintered. For the members of the fourth generation, their share in the company is no longer “ownership”; it has become an “investment.” They want to diversify rather than to keep all their financial eggs in the family-company basket, and thus want the company to be sold or to go public.

By contrast, maintaining the family company is usually the best course for the second or even third generation. Often it is the only course, as the business is not big enough to be sold or to go public. And it surely also is in the public interest. The economy needs entrepreneurship. The growth dynamics in the economy are shifting fast from the giant company toward the medium-sized one–and that tends to be such an owner-controlled and owner-managed company.

Unfortunately, the family-managed business that survives the founder–let alone one that still prospers–let alone one that still prospers under the third generation of family management–is still the exception. Far too few of these businesses accept the one basic precept that underlies all four of the rules outlined here: Both the business and the family will survive and do well only if the family serves the business. Neither will do well if the business is run to serve the family.