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Making of a family business

At first, it’s hard to put your finger on what makes Hannay Reels such a successful company.  This family-run manufacturer of hose reels is nestled in the Helderberg Mountains in Upstate New York – a location that doesn’t afford a particularly strong strategic advantage. In fact, you could argue that being in a US state that abounds in regulations, taxes and labour costs might logically undermine its market position among competitors.

But Hannay Reels has something special: a legacy of ‘homespun culture’ that Roger Hannay and his family continue to practise with their customers and 150 employees, all of whom they call ‘part of the family’. It’s been the backbone of their healthy USD 45 million-a-year business since 1933.  “I suppose we could hire professionals to run the business and be silent owners, but I don’t know of any other way to do business"  Hannay says.

Visitors to Hannay Reels, in the community of Westerlo, about 20 miles south of Albany – a client of UHY’s firm in the US, UHY Advisors – may not realise that the quaint office where people bring you coffee and take your coat is the company’s nerve centre that competes on the frontlines of a global marketplace. You get the sense you’ve gone back to a day when personal contact was paramount to maintaining strong customer relationships and promises made for delivery dates and high-quality products were kept.

Hannay Reels each year makes nearly 80,000 high-quality hose and cable reels using tonnes of steel, stainless steel and aluminium. The reels are used in industries from fire-fighting to fuel delivery and deep-sea exploration.

The company’s so-called ‘secret sauce’ – while competitors from China and other emerging markets offer lower-cost alternatives – is what matters most. “We have a motto here: ‘Built to last, delivered fast" says Hannay. “Because of this commitment, we’ve somewhat insulated ourselves from low-cost competitors."

Core strengths 

So what can family businesses worldwide learn from the likes of Hannay Reels? 

Retaining a stable workforce has long been a core strength of the company – employees are with the company on average for 20 years, and many employees’ families have enjoyed several generations of parents, children, spouses, siblings and cousins at the plant.

But, exceptional employee loyalty apart, Hannay offers other tips for a successful family business:

  • Make it in your own country – Companies should do everything they can to make their goods in their own country. They shouldn’t outsource simply to make a greater profit, but rather find other ways to be competitive, such as identifying markets that appreciate quality products, speedy delivery and good old-fashioned customer service.

  • Commit to your community – It’s hard to think of what Westerlo, and surrounding rural towns, would be without Hannay Reels, which employs about 150 workers and contributes significantly to the tax base and local economy. The company and its employees also give generously to causes in the region and beyond.

  • Customers are king – This axiom will never go out of style, says Hannay. Everything you do needs to be focused on the customer’s experience, from ordering the product to using it.

  • Make leaders accessible – Don’t hide in your office. Regularly get out and walk the production floor to observe and talk with employees. “I answer my own phone when anyone calls and our customers prefer that", says Hannay.

  • A stable, quality-driven workforce makes it all possible – Get to know your employees by name and be there for them. Trust in them and they will generally respond with quality work. “Some of our reels made more than 50 years ago are still being used today", says Hannay.

  • Keep it in the family – Too many family businesses allow outsiders to have ownership, such as through private equity investors. “It can dilute the common philosophy and approach to major areas of the business,“ says Hannay. “Only family members who are active in the company should hold stock."

  • Say little, do much – It’s worked for every generation since Clifford Hannay made his first reel in the 1930s — and now Hannay Reels is a leader in its industry sector. 

Family businesses like Hannay Reels are all around us — from neighbourhood stores and the millions of small and mid-size companies that underpin many economies, to household names such as BMW, Samsung and Wal-Mart. One-third of all companies in the S&P 500 index, and 40% of the 250 largest companies in France and Germany, are defined as family businesses, meaning that a family owns a significant share and can influence important decisions, particularly the election of the Chairman and CEO.

Key activities for success  

So what else can we learn from family businesses? Research by global business consultants McKinsey pinpoints five key activities that must work well and in synchrony for family businesses to be successful.  

They are:

  • ­Harmonious relations within the family and an understanding of how it should be involved with the business

  • An ownership structure that provides sufficient capital for growth while allowing the family to control key parts of the business

  • Strong governance of the company and a dynamic business portfolio

  • Professional management of the family’s wealth

  • Charitable giving­ to promote family values across generations.
     

The research also shows that family businesses tend to have lower levels of financial leverage, and a lower cost of debt, than their corporate peers; and that publicly traded, family-influenced companies often have higher shareholder returns than do companies in leading indices such as MCSI Europe, MSCI World and S&P 500.

Generational issues 

As family businesses expand from their entrepreneurial beginnings, they often face performance and governance challenges. For example, generations that follow the founder may insist on running the company, even though they are not suited for the job. And, as the number of family shareholders increases exponentially generation by generation, with fewer family members actually working in the business, the commitment to carry on as a family business cannot be taken for granted.

Indeed, less than 30% of family businesses survive into the third generation of family ownership. However, those that do so tend to perform well over time compared with their corporate peers.

“To be successful as both the company and the family grow, a family business must meet two intertwined challenges: achieving strong business performance and keeping the family committed to, and capable of, carrying on as the owner" say the McKinsey researchers.

Family businesses can go under for many reasons, including family conflicts over money, nepotism leading to poor management, and in-fighting over the succession of power from one generation to the next. Regulating the family’s roles as shareholders, board members and managers is essential because it can help avoid these pitfalls.

Large family businesses that survive for many generations ensure they permeate their ethos of ownership with a strong sense of purpose. Over decades, they develop oral and written agreements that address issues, such as the composition and election of the company’s board, the key board decisions that require a consensus or a qualified majority, the appointment of the CEO, the conditions in which family members can (and can’t) work in the business, and boundaries for corporate and financial strategy.

The continual development and interpretation of these agreements, and the governance decisions guided by them, may involve several kinds of family forums. A family council representing different branches and generations of the family, for instance, may be responsible to a larger family assembly used to build consensus on major issues, says McKinsey.

Long-term survivors usually share a meritocratic approach to management. There’s no single rule for all, however — policies depend partly on the size of the family, its values, the education of its members, and the industries in which the business competes.

For example, the Australia-based investment business ROI Group, which now spans four generations of the Owens family, encourages family members to work outside the business first and gain relevant experience before seeking senior-management positions at ROI. Any appointment offered to them must be approved both by the owners’ board, which represents the family, and the advisory council, a group of independent business advisors who provide strategic guidance to the board. 
As families grow and ownership fragments, family institutions play an important role in making continued ownership meaningful by nurturing family values and giving new generations a sense of pride in the company’s contribution to society.

Ownership issues  

How to maintain family control or influence while raising fresh capital for the business and satisfying the family’s cash needs is a juggling act that must be addressed, as it’s a major source of potential conflict, particularly in the transition of power from one generation to the next. Enduring family businesses regulate ownership issues — for example, how shares can (and cannot) be traded inside and outside the family — through carefully designed shareholders’ agreements that often last for 15 to 20 years.

Many family businesses are privately held holding companies with reasonably independent subsidiaries that might be publicly owned. Though in general the family holding company fully controls the more important ones. By keeping the holding private, the family avoids conflicts of interest with more diversified institutional investors looking for higher, short-term returns. Financial policies often aim to keep the family in control. Many family businesses pay relatively low dividends because re-investing profits is a good way to expand without diluting ownership by issuing new stock or taking on big debts. “In fact, some families decide to shut out external investors of the entire business and fuel growth by re-investing most of the profits, which requires good profitability and relatively low dividends" says McKinsey. “Others decide to bring in private equity as a way to inject capital and introduce a more effective corporate governance culture." 

Others take the Initial Public Offering (IPO) route and float a portion of the shares. An IPO can also be a way to provide liquidity at a fair market price for family members wanting to exit as shareholders. To keep control, many family businesses restrict the trading of shares. Family shareholders who want to sell must offer their siblings, and then their cousins, the right of first refusal. In addition, the holding company generally buys back shares from exiting family members. Payout policies are usually long-term to avoid decapitalising the business.

Because exit is restricted and dividends are comparatively low, some family businesses have resorted to ‘generational liquidity events’ to satisfy the family’s cash needs. These may take the form of sales of publicly traded businesses in the holding, or of sales of family shares to employees, or to the company itself, with proceeds going to the family.

With clear rules and guidelines as an anchor, family enterprises can get on with their business strategies.

Strong governance 

Large and durable family businesses also tend to have strong governance. Members of these families avoid the principal–agent issue by participating actively in the work of company boards, where they monitor performance diligently and draw on deep industry knowledge gained through a long history. On average, 39% of family business board members are directors from within the business (including 20% who belong to the family), compared with 23% in non-family companies, according to the S&P 500.

Of course, it’s important to complement the family’s knowledge with fresh strategic perspectives of qualified outsiders. Even when a family holds all of the equity in a company, its board will most likely include a significant proportion of outside directors. One family business has a rule that half of the seats on its board must be occupied by outside CEOs who run businesses at least three times larger than the family one.

Procedures for all nominations to the board — insiders as well as outsiders — differ from company to company. Some boards select new members and then seek consent from an inner family committee and formal approval by a shareholder assembly. Mechanisms differ: what counts most is for the family to understand the importance of a strong board, which should be deeply involved in top-executive matters and manage the business portfolio actively. Many have meetings that stretch over several days to discuss corporate strategy in detail.

Family businesses, like their non-family peers, face the challenge of attracting and retaining world-class talent to the board and to key executive positions. In this respect, they have a handicap because non-family executives might fear that family members make important decisions informally and that a glass ceiling limits outsiders’ career opportunities. Yet, family businesses often emphasise caring and loyalty, which some talented people see as values above and beyond what non-family corporations offer.

Long-term growth strategies 

Successful family companies usually seek steady long-term growth and performance to avoid risking the family’s wealth and control of the business. This approach shields them from being tempted to pursue maximum short-term performance at the expense of long-term company health. Longer-term planning, and more moderate risk-taking, serve the interests of debt holders too, so family businesses tend to have not only lower levels of financial leverage but also a lower cost of debt than that of their corporate peers.

The longer perspective may make family businesses less successful during booms but increases their chances of staying alive in periods of crisis and of achieving healthy returns over time. In fact, despite challenges facing family-influenced businesses, from 1997 to 2009 a broad index of publicly traded ones in the US and Western Europe achieved total returns to shareholders two to three percentage points higher than those of the MSCI World, the S&P 500, and the MSCI Europe indexes. 

This long-term focus, says McKinsey, implies relatively conservative portfolio strategies based on competencies built over time, coupled with moderate diversification around the core business and, in many cases, a natural preference for organic growth. 
Family-influenced businesses also tend to be prudent in mergers & acquisitions, making smaller but more value-creating deals than their corporate counterparts do, according to McKinsey’s analysis of M&A deals worth more than USD 500 million in the US and Western Europe from 2005 to late 2009. The average deal of family businesses was 15% smaller, but the total value added through it — measured by market capitalisation after the announcement — was 10.5 percentage points, compared with 6.3 points for their non-family counterparts. 

Wealth management 

Nonetheless, too much prudence can be dangerous, says McKinsey. Family owners, who usually have a significant part of their wealth associated with the business, face the challenge of preventing an excessive aversion to risk from influencing company decisions. Excessive risk aversion might, for example, unduly limit investments to maintain and build competitive advantage and to diversify the family’s wealth. Diversification is important, not only for overall long-term performance but also for control, says McKinsey, because it helps make it unnecessary for family members to take money out of the business and diversify their assets themselves. That’s why most large, successful family-influenced survivors are multi-business companies that renew their portfolios over time. 

  • Five key factors increase the chances of wealth management success:

  • A high level of professionalism through institutionalised processes and procedures

  • Rigorous investment and divestment criteria

  • Strict performance management

  • Strong risk-management culture, with aggregated risk measurement and monitoring

  • Thoughtful talent management. 

McKinsey adds: “Almost all companies start out as family businesses, but only those that master the challenges intrinsic to this form of ownership endure and prosper over the generations. The work involved is complex, extensive, and never-ending, but the evidence suggests that it is worth the effort for the family, the business and society at large." 

UHY has offices in most major business centres around the world. For details of UHY’s family business support in your region, please contact the UHY executive office.