New Insights into Family Business Succession: Who Owns the Family Business?

New Insights into Family Business Succession and Wealth Management
 

In China, many entrepreneurs take father-to-son business succession for granted, but this is not the only option. Whether the family can continue to own the business often depends on the ability of the enterprise to overcome the obstacles that lay ahead; whether the family should continue to run the business will depend on the ability of the enterprise to maintain and enhance the value of family intangible legacies.
 

Over the past three years, the most popular phrase in the wealth management market has been “family business”, followed by “wealth management”.
 

According to a report from McKinsey, there were a total of 1,288 family businesses with the annual sales of more than US$ 1 billion in emerging markets, including China, in 2010; the number would skyrocket to 5,608 by 2025. In China, private companies can be divided into family businesses and non-family businesses; 747 family businesses make up around 50% of private companies, creating a blue ocean of wealth management.
 

Why does family business succession falter?


Research has indicated that family businesses in Hong Kong lose 80% of their market capitalization from five years before succession to three years after succession. The weighted average market capitalization of family businesses in three regions evaporates by 60%. Whether for the family or shareholders, business succession that does not work well will be an expensive drain on family wealth. In terms of business indicators, the results for family firms that have embarked on succession pale in comparison with those that have yet to pass the baton to a successor. In other words, both capital market performance and operating results have proven succession is a hard nut to crack.
 

1 A Tangled Web of Relationships during Family Business Succession

Non-family businesses are made up of shareholders, employees who hold shares and employees who do not hold shares. In family businesses, these relationships multiply into seven types, making business succession all the more challenging.




2 Different Windows of Time between Family Businesses and Non-Family Businesses

The operations cycle of listed companies range from two to three years to five years till ten years. The operations of family businesses span from one generation (no fewer than 20 years) to two generations till three generations. Thus, family business owners have to make tough choices.
 

3 Different Categories of Assets between Family Businesses and Non-Family Businesses

Listed companies generally hold financial assets only; family firms are also endowed with intellectual assets, human assets and social assets.
 

4 Obstacles to Family Business Succession

During succession, family firms are faced with barriers in terms of equity, business, personnel and social relationships.

 

Passing the baton to the son is not the only choice.
 

The objectives of family businesses include not only the maximization of shareholder value or wealth, but also family happiness, social harmony and a built-to-last business. The rights to the family business fall into the category of ownership and control, which are generally separated as the company goes from strength to strength. There are many different business succession approaches, as illustrated in Figure 2:



1 Children take over the father’s business.

Children take over equity, ownership and control from their father to keep the family business going. The so-called succession within the family ensures the continuity of the corporate governance model.
 

2 The family business is controlled by the family but run by non-family members.

Children, who hold stakes in the company, serve only as responsible shareholders and beneficiaries. Shareholders usually focus on potential investment projects, while entrepreneurs put a premium on the craftsman’s spirit. Thus, when the family business is left in the hands of a professional manager after the establishment or founder’s retirement, the governance model will shift into family ownership and professional management.
 

3 The family business is neither controlled nor run by the family.

The listing of the family business results in the dilution of equity, and family members turn into minority shareholders, transferring ownership to a professional manager. Nevertheless, family members remain engaged in business management. Thus, the governance model features external ownership.
 

4 The family business is run by the family, but controlled by non-family members.

The family gives up both control and ownership, making the family business a public company.
 

Who owns the company? Someone once said, “The family business is not inherited from our parents, but borrowed from our children.” By taking this a step further, we can conclude that the family business is borrowed from society. The allocation of wealth created by the family business matters a great deal.
 

These different succession models each entail a different approach to grooming the successor. For the first model, the key lies in family governance and grooming of the successor. If the family holds ownership only, giving control to a professional manager, corporate governance and professional managers matter most; children need to act as responsible shareholders. If the family remains in charge of the business while giving up ownership, more attention should be paid to family governance, training of the successor, and management of assets or wealth following equity transfer. If the family withdraws from the business, wealth management matters most.
 

The wealth management market needs to face up to return on investment. Research studies have shown that 13.5% of Chinese extra-HNWIs’ assets go into alternative investments, such as structural products, derivatives, bulk goods, private equity, and hedge funds; fixed-income products make up 17.2%, stocks 26.5%, cash and cash equivalents 23.3%, and real estate 19.5%. In China, extra-HNWIs have poured a disproportionate portion of assets into real estate; they have allocated far more domestic assets than overseas ones.
 

Over the past few years, ROI in the Chinese market does not make sense. Due to rigid repayment, grave moral risks have resulted in market distortion.
 

From 1926 to 2010, the annual average inflation rate stood at 3.6% in the US. Blue-chip stocks generated a 10% inflation-adjusted ROI on average; high-growth small-cap stocks 12%; long-term, mid-term and short-term Treasuries 5.5%, 5.4% and 3.6% respectively.
 

In the US, real estate gave a 7% yield; commodities trading a 6.9% yield; hedge funds an annualized 12.2% yield, lower than that of China’s wealth-management products. The yield on PE/VC was only 12.5%. A 50% yield was out of the question; only a Ponzi scheme would perhaps generate such enormous returns.


 


Oliver Rui
Zhongkun Chair in Finance at CEIBS, Professor of Finance and Accounting;
Co-Director, CEIBS Centre for Family Heritage