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July 20, 2015
Family Owned Businesses are Different.
The traditional approach to dealing with Family Owned businesses is to assume that they are driven in the same way that conventional businesses are driven. Adam Smith, author of the seminal treatise “An Inquiry into the Nature and Causes of the Wealth of Nations (1776), referred to maximising owner’s wealth. Other great economists such as Nobel Laureate, Milton Friedman, also espoused the concept of maximising shareholder wealth and hence it has become an accepted idiom that this is the goal of a firm. Because of this general acceptance, advisers, including lawyers, accountants and financial planners, have all assumed that this is the case and that all firms act in the same rational manner.
Research indicates that this is not always the case. A study conducted by the Monash University Centre for Accounting Research, Characteristics of Family Owned Businesses (Baring, 1990) asked the following question:
“If you had a vacancy in your firm (family owned) and a member of your family was unemployed. Would you employ the family member even though his/her skill set did not match the vacancy”?
The initial response to this question had 24% affirmative and 76% said they would not employ the family member. The research group felt that this response was counter intuitive and went back to a sample of respondents. The respondents affirmed their initial response but then added a rider which was, “that is, unless the family member could not get a job elsewhere, then of course we would employ them. In addition we would probably employ another person to support them”. Hence the concept of wealth maximisation ceases to be the primary objective of the family firm in many instances (more than 50% in this research). As private companies represent more than 98% of all businesses and more than 50% of all private companies are family owned it is indicating that investment strategies based on the concept of wealth maximisation may be inconsistent with the true objectives of a family owned business. Although many small firms are family owned businesses there are also many large and public listed companies that are also family owned/controlled.
What Does this Mean for Advisers?
The primary consideration is that any adviser that treats a family business as if it is a conventional business with wealth maximisation as the primary goal may get things entirely wrong. Every family owned business is unique and there is no “one size fits all” solution. Advisors need to adopt the approach of “knowing your customer” (KYC) and that includes all aspects of their business. The advisor needs to understand the various roles of family members in, or with the potential of being in, the business. He/she needs to know the succession plan, the financial plan, the estate plan all of which are important roles of the wealth planning process but are not, in themselves, wealth planning. This point is not clearly understood as it is common for a legal adviser, for example, to advise a family business client about estate planning assuming that this is all that is required for wealth planning. Estate planning, as are the other elements mentioned above, is a critical element of wealth management but is not, in itself, wealth planning.
The solution for family business advisors is clear. Do not assume that a family business will, or wishes to act as a conventional business. In order to provide sound advice the advisor should ensure that he/she understands the dynamics of the business and then adopts a holistic approach to addressing the wealth management issue in order to do justice to the important role that the client is assigning to you.
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