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Family business – a definition

The terms family business, family firm, family company and family owned business are used interchangeably and many times over but often without the speaker or writing saying precisely what is meant by those terms. Most of us think that we know what a ‘family business’ is.  The truth is that there is no universally accepted definition. A 2008 study commissioned report by the European Commission[i] identified more than 90 separate definitions in use.  It is certainly not our intention to comment on all of these, much less to suggest a 91st.Various academics and commentators have come up with their own formulation.  Different surveys use different definitions of family businesses, making it correspondingly harder to compare results and research.We will look at some of the main definitions in this section.The world leading family business advisory network, the US based Family Firm Institute (FFI) tell us that a family business:-“may consist of one or more activities, such as an operating business only;  alternatively the enterprise might include real estate leased to the business.  Another possible configuration is an operating business with a diversified wealth portfolio held for the benefit of the family, often referred to as a family office”[ii]

 

This is not so much a definition but more of a recognition that a family business can take of various forms and therefore the complexity, bordering on the impossibility, of arriving at a single, succinct but comprehensive definition of family business.

One approach could be to break the expression family business down into its component parts.

 

The logical starting point would be first to look in detail at the definition of family.  But this apparently simple concept is itself fraught with difficulty and so will be considered separately.  For the time being it will be sufficient to think of a family as the founder of the business, their spouse or partner together with the founder’s direct descendants.

 

European Commission definition
The 2008 study led to a final report by a group of family business experts drawn from across Europe, recommending a formulation which appears to be gaining traction[iii] as a leading definition and is recommended for use by the European Commission.   According to them:-
A firm, of any size, is a family business, if:
(1) The majority of decision-making rights is in the possession of the natural person(s) who established the firm, or in the possession of the natural person(s) who has/have acquired the share capital of the firm, or in the possession of their spouses, parents, children or children’s direct heirs.
(2) The majority of decision-making rights are indirect or direct.
(3) At least one representative of the family or kin is formally involved in the governance of the firm.
(4) Listed companies meet the definition of family enterprise if the person who established or acquired the firm (share capital) or their families or descendants possess 25 per cent of the decision-making rights.

 

We will adopt the EU Commission definition as our basic starting point.  We will also explore some of the issues raised by the expert group definition, many of which have historically caused family business commentators to grapple with alternative formulations.

 

Large businesses
The expert group make it clear that their definition of a family business applies to “a firm, of any size”.  Larger companies such as Clarks potentially qualify.  At the time of writing, the descendants of the founder brothers, James and Cyrus Clark, still hold the vast majority of the shares in the company.  Whilst no Clark family members currently hold senior executive positions there are family appointed non-executive directors and many more family members are involved in the family council and therefore “in the governance of the firm”.

 

Similarly with News Corp.  Although the business is listed on the New York Stock Exchange, the Murdoch family control in excess of 25% of the voting rights, largely through the separate class of shares held by them carrying weighted voting rights.

 

But there are many other businesses, which technically fall within the European Commission definition but simply do not feel like they are family owned.   A 2015 Credit Suisse survey[iv] uses a similar definition of family business but with a 20% shareholding threshold for quoted companies to qualify.  On that basis Google and Facebook are both treated as family businesses, presumably because of the retained shareholdings and continued involvement of their founders.   But neither Google nor Facebook[v] look and feel like they are family businesses.   Why not?

 

Owner managed or a family business?
There will be many businesses where the EU Commission fits both the technical circumstances and the look and feel of the family business concerned.   These may be smaller family owned farming partnerships or family companies with two generations or siblings of the founder working side by side.

 

The basic structural difficulty with the European Commission definition is that, by simply looking for a majority of voting rights, all single-founder controlled owner-managed businesses will automatically be treated as family businesses.   This fits with the intention of the expert group.[vi]  The expert group were keen to focus on simplicity and to arrive at a definition that was ‘operational’.

 

Many such businesses will remain very much their founder’s.   They may never pass any part of the ownership to or employ any other family members.  Can such businesses truly be said to be family businesses?   Most commentators would say not.  Something else is required.  Exactly what the missing ingredient is has led to the other 89 definitions and consumed countless hours of debate in the family business world.

 

Wider ownership
It may help in getting closer to that a more precise definition if at least two family members participate as owners or if a large percentage of the business is held by the wider business owning family.  But this is not decisive.

 

A business may clearly be seen as a family business under all other criteria even if it is owned exclusively by a founder or a single current generation family shareholder.   For example a family farm where the senior generation retain ownership but the next generation also live and work full time on the farm.

 

But wider family ownership might not be decisive in capturing the essence of a family business.  Handing on shares may be the start of an ownership succession exercise.  Conversely it might simply be a tax planning exercise, with the intention of the founder, always being to sell ‘his’ business as and when they thought the time and price was right.

 

Multi-generational
Is it necessary for at least one intergenerational transfer or succession to have taken place before a business can truly be seen as a family business?   Although some academics take this approach[vii] this is very much the minority view.

 

Succession intention
Is the missing ingredient therefore that the founder or current generation intend to pass the business on to the next generation?

 

Dr Peter Davis[viii] suggests that this is so.  He argues that some additional ingredient is required before an entrepreneur can be regarded as the founder of a family business:-

 

“Founders are typically intuitive and emotional people.  They obviously have the drive and ambition to build a great business, but they also have a feeling about the place, a love of what they have created that makes them want to perpetuate it through the generations.”

 

John Ward also sees an element of succession intention as crucial and defines a family business as:-

 

“….one that will be passed on for the family’s next generation to manage and control”[ix]

 

Of course intending to pass the family firm to the next generation and actually doing so are two different things.  This issue of uncertainty inherent in Ward’s formulation can be sidestepped by introducing the qualification that a family business is one that the family intend will be passed onto the next generation.  But even such a revised definition still disqualifies businesses, run by a wide coalition of family members, where there is either a positive intention for the business not to pass to the next generation or even an open mind as to whether or not that is a good idea.

 

Family involvement in management
So is the crucial question how many family members are involved in the business?   The European Commission definition requires that “at least one family member is involved in the formal governance structure of the business” so the test would be satisfied by the presence of a founder alone.

 

Again that definition could be modified for example by requiring the involvement of at least two family members.  But there will be a number of businesses where the decision-making and management rests with a single-family member but where there is a clear intention to pass the business on to the next generation and to involve them in management when they are ready for this.   Again many farming businesses will fall into this category, with the next generation already earmarked for their roles as successors before they have started school.

 

Conversely the mere presence of other family members in a notional governance capacity will do little to create or maintain a true family business.

Mere token family presence is therefore not enough to capture the essence of what it takes to be a family business.  In their seminal article introducing the Three Circle Model Tagiuri and Davis define family businesses as organisations where:-

 

“two or more extended family members influence the direction of the business through the exercise of kinship ties, management roles or ownership rights”[x]

Active involvement and participation in day-to-day management by the wider family could therefore be part of the missing ingredient.  But this is not really necessary.

 

Family owned and family managed business
A key distinction to make so far as family businesses are concerned is between, on the one hand, family managed businesses and, on the other, family owned businesses.   In the former, family managed business, the business family will, in addition to owning all or most of the business, perform the vast majority of senior management roles.   These tend to be early stage or smaller family businesses.

 

The term family owned business usually implies that, whilst the business family have made a commitment to retaining all, or the vast majority of ownership rights, many, and in some cases all, of the senior executive management positions, are occupied by non-family managers.  Larger and later stage family business conforming to this description are more typically described as family owned.

 

The distinction between ownership and management is one of the key concepts in family business work.  Achieving the right blend between family involvement, thereby leveraging the advantages of the family business model referred to above and non-family expertise, to help dispel or dilute the corresponding disadvantages, remains a central and perennial challenge for the business owning family.  This key theme of professionalisation is explored in Advising the Family Owned Business.

 

Other academic commentators argue that it is necessary to take a more detailed look at a combination of family involvement in ownership (FIO) and family involvement in management (FIM) to obtain a rounded view of a family firm.[xi]  Their work suggests that there is an adverse correlation between the number of family members involved in management and family firm performance.  We would argue that whilst this research may highlight a potential defect in the family business model, it should be seen as signposting potential traps to avoid, rather than exposing any fundamental flaw in that model.   Any potential negative impact of over-reliance on family management can be overcome by an investment in non-family professional managers and governance.  This is a matter of debate.

 

Most of the elements of the definition of family business we have discussed so far have been quantative.  Some have been simple threshold tests such as those contained in the European Commission definition.   Other quantative measures like the FIM FOM analysis work look at degrees of involvement.

 

‘Familiness’
Is there an additional intangible element also needed before a business can truly be classed as a family concern?  For want of a better word, ‘familiness’.   This is hinted at by reference to active language such as ‘influence’ and exercise’ in the Tagiuri and Davis definition.  It is also implicit in concepts such as succession intention.    If so the European Commission definition could be seen as an entry point or as a provisional qualification for treatment as a family business.  Some further characteristics would then need to present to confirm that family business status.

 

As these intangible factors are not absolutes but a collection of variables, the relative strength or absence of the various factors will determine how securely (or otherwise) any qualifying business can be seen to qualify as a family business.   In some cases the absence of many of the factors comprising familiness may mean that, a founder managed enterprise will, on closer analysis, lose its provisional family business status.

 

Although they do not use the familiness expression this is essentially the argument employed by Astrachan et al in developing their F-PEC Scale of Family Influence[xii].   Their approach is to look at the influence of the family in three areas, power experience and culture.   The higher a business scores on their F-PEC scale the more that it can be seen as a family business.   Looking at the elements of the scale in a little more detail.

  • Power is itself broken down into three separate elements assessing the involvement of the wider business owning family in ownership, management and governance.
  • By which the authors mean how long has this family been in business together?  The more generational transitions it has survived the higher its F-PEC factor.[xiii]  For example many family farming businesses have been through a sufficient number of generational successions that they can be said to have developed a succession gene.

 

To what extent do the family share a common view on the strategy and values of their family firm and above all a commitment to it remaining in family ownership?

 

The F-PEC scale attempts to quantify what might otherwise be seen as unquantifiable, intangible elements of family business life.  But as the starting point of the model is a questionnaire based on the inevitably subjective views of family members, even a methodology as complex as the F-PEC scale might not deliver an absolutely robust analysis of the relative degree of familiness of any particular family business.

 

However the approach does move us way beyond the simple analysis of ownership thresholds and family governance participation into an examination of the contribution made by the wider business owning family to their family business.  In this way it could be a useful tool to examine the relative strengths and weaknesses of the family as a business family.  Does the family hope to remain in business together for the foreseeable future?  If so an analysis based on the F-PEC approach may allow them to identify weaknesses and build on strengths and thereby to turn that dream into a reality.

 

Self definition
A number of studies allow participants to self define whether or not they are family businesses.[xiv]  This might marginally affect the robustness of survey results.  A number of businesses that would otherwise qualify as family businesses might exclude themselves from the survey.

 

Recognition by a family that they are working together in a family business is clearly helpful.  The family are more likely to appreciate both the benefits and challenges of this.  But relying exclusively on self-definition may cause difficulties for family businesses and their advisors.

 

We have encountered many businesses that certainly qualify as family businesses under the criteria of the European Commission test but do not see themselves as such.  Instead they see themselves as corporates who just happen to have some family shareholders.  It might be that such businesses would score low on the F-PEC scale in terms of their family involvement.   Nevertheless family dynamics will apply and family expectations may have arisen. For example the next generation might have an expectation to work in or even own what they see as ‘the family business’.  By failing to recognise the reality of their family business situation the family are at a greater risk of ignoring the inevitable issues arising from family dynamics.

 

The most graphic illustration we have encountered of this relates to the sale of a medium sized business some years ago.  In addition to the first generation founder both his son and daughter worked in the business, occupying senior management positions. The founder’s initial instructions were that the son and daughter were not to be told about the proposed until after completion.  Those instructions were soon revised.

 

The maxim goes that one can never take the family out of the family business.
Is Dyson’s a family business?
To conclude our discussion on the definition of a family business we will look at the Dyson appliance business founded by Sir James Dyson in 1978 and with a public image that is still very much synonymous with its founder.  The company is described on the Dyson website[xv] as a “technology company with over 1,000 engineers worldwide.”  The business is privately owned and whilst ultimate beneficial ownership of the shares is not readily apparent from public records it is believed that this sits with Sir James and his family.

 

The company has a non-family CEO but, its public image is inextricably linked to Sir James, who features on advertising etc.  In addition to Sir James, various members of the Dyson family occupy board positions within the overall company structure. Dyson therefore clearly falls within the European Commission definition of a family business.

 

But can Dyson truly be seen as a family business, rather than Sir James’ business, or a technology company in which the wider family have an interest and occupy governance roles?

 

The argument for family business categorisation may have been strengthened by the acquisition by the parent Dyson business of Dyson Lighting, a business set up by James Dyson’s son Jake supplying high end LED lamps which led at least one business commentator to conclude that this acquisition “puts Jake in pole position to succeed his father.”[xvi]

 

Whilst it would seem that Dyson would clearly qualify as family business under the European Commission definition it remains to be seen quite where Dyson would be placed on the F-PEC scale.

 

References:
The text above has been almost entirely extracted from a book, Advising the Family Owned Business written by FBC consultant Nicholas Smith.

[i] Overview of Family Business Relevant Issues – Final Report 2008

[ii] Family Enterprises: Understanding Families in Business and Families in Wealth.   The Family Firm Institute Inc., 2014 Wiley Inc. glossary at page 147.  This book devotes a whole 38 chapter of 38 pages to the subject of Defining the Family Enterprise.

[iii] The first trace we have of this definition comes from The Family Entrepreneurship Working Group set up by the Finnish Trade Ministry in 2004 but the definition was adopted in the European Commission Final Report Of The Expert Group on Family Business Relevant Issues in 2009

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