Many investors see family owned or influenced businesses, that means companies where a family holds a significant stake, as very small and usually privately held. The reality however is very different.

By Lars Kalbreier, Chief Investment Offier of Vontobel Wealth Management, based in Zurich

Family influenced companies comprise widely known names across the globe, such as LVMH in France, Tata Group in India, Wahaha Group in China or Hong-Kong-based CK Asset Holdings.

One of the most debated topics among researchers into family businesses is how to define one in the first place.

What Qualifies as a Family Business?

The family business expert group of the EU defines listed companies as family businesses if the person who founded the company, or has acquired the share capital of the company, or that person’s family or descendants, due to their share capital, hold 25 percent of the decision making rights.

This definition also includes family businesses that have not yet undergone the first generational transfer. What is not contested, however, is the importance of family businesses to the economy.

Stability in Times of Market Turmoil

There are 14 million family businesses in the EU, providing more than 60 million private sector jobs, and while success can be measured in many different ways, our research finds that family businesses share key attributes that can make them particularly appealing to investors.

Not only do they often generate superior earnings growth, have a longer-term strategic vision and demonstrate stability in times of market turmoil.

Following a Code of Ethics

We have also found that their revenue growth is stronger, their cash flow returns significantly higher, and their balance sheet discipline more conservative than their non-family peers’.

Corporate social responsibility (CSR) is a further hallmark that sets family businesses apart from the rest with 81 percent of family businesses engaged in philanthropy and 85 percent following a code of ethics, compared to only 57 percent of the world’s largest companies.

At Least One Woman on the Board

When it comes to gender diversity, family businesses are more advanced, too: A study conducted by the global consultancy firm Ernst & Young (EY) found that 55 percent of family businesses surveyed have at least one woman on the board of directors, compared to only 19 percent of Fortune 500 companies.

While being progressive on the one hand, they tend on the other to be more conservative when exploring new business ventures, for example when it comes to M&A transactions. Embedded in their conservative focus is also a tendency to finance new investments via organic cash flows, resulting in lower debt levels.

Specific Challenges

Succession planning is a key hurdle for family businesses. In their early stages, family businesses tend to center around the founder or founding family.

This usually works well for the first two generations. Yet the more the company matures – and the family grows – the more complex become both the environment in which it operates and the challenges it faces. The numbers are striking: only one third of family-owned companies make it into the third generation, and a meager 4 percent into the fifth.

Independant External Experts

Oftentimes, this is where the company can benefit from enriching its governance structure by including independent, external experts to the board of directors. Independent directors can offer valuable insights and an unbiased view, and can improve the overall performance by ensuring a system of checks and balances.

As part of our research on this theme, we have found that in particular, shares in companies where family participation is balanced by an independent board have consistently outperformed the global stock market since 2006.

Impatient Shareholders

To draw a clear distinction, we therefore refer to our investment strategy as «Family influenced,» rather than «Family owned,» and we use this participation metric as one of our selection criteria.

All the above aspects condense into a longer-term strategic orientation among family businesses. Many companies nowadays tend to focus on short-term results, steering the firm from one quarterly result to the next in order to please impatient shareholders.

Particularly Appealing

When referring to companies with good governance structures, investors often refer to a so-called alignment between management and shareholder interests. Awarding managers shares in the companies they manage is a tool that has been employed in an attempt to replicate the success of family businesses. Family businesses, however, have another layer of shareholders to please: the next generation.

Within families, the effect of one’s strategic decisions is more pronounced than in any other company type. This fosters a management approach in which the firm’s money is ultimately treated as if it were the family’s money. With the right governance structures in place, this can be particularly appealing for the remaining shareholders.

Preparing For the Years to Come

The principle of cause and effect on future generations is omnipresent. In one of its surveys, EY found that more than 80 percent of family businesses will change hands in the next ten years, with prudent succession planning a make-or-break factor for the continuance of a family’s influence in a company.

Determining how to approach this can be highly sensitive and requires many aspects to be taken into account. On the one hand, the roles of key family members, who have shaped the company with their entrepreneurial skillset, need to be defined. On the other hand, the future ownership structure needs to be addressed.

Successful Families

Not every younger generation is interested in following the path their parents have paved for them, and where there are family members interested in continuing the efforts of a previous generation, they might not necessarily have the correct skillset.

Many successful families have given the next generation time to gather external experience, so that one or two selected successors are able to take over when an older family member steps down.

Training the Next Generation

While most people think this is primarily needed to prepare the next generation for the technical requirements of the job, another factor is at play here: training the next generation to be stewards of wealth across generations.

Investors refer to this as fiduciary duty; the legal obligation of those entrusted with the care of money to act in the best interest of the investor. Sometimes it‘s easier to trust family.