Family companies are experiencing heir loss

Family companies are experiencing heir loss

FAMILY COMPANIES are the hidden engines of the global economy. More than 90% of all companies are family companies. These include many of the world’s biggest organizations such as LVMH Moet Hennessy Louis Vuitton SE in France and Samsung Electronics Co. in South Korea. A third of companies in Standard & Poor’s 500 index and 40% of the largest companies in France and Germany have a strong family element.

Yet thanks to a combination of demographics and changing social mores, many family firms now face the ultimate threat to their survival: a shortage of heirs. Good riddance, you might say, after watching the psychopathic antics on Succession. That ignores the importance of the best family firms not just as engines of progress and innovation, but as repositories of public trust, especially at a time when trust in capitalism is at an historically low ebb.

Even if family companies grow to be behemoths like Succession’s Waystar RoyCo, family companies are inherently fragile organizations. This is partly because they are so prone to family feuds but also because producing a capable heir is hard. Nonfamily companies have the advantage of choosing successors from the entire universe of management talent. Family-run companies are restricted by DNA.

This restriction was manageable in the pre-modern era when birth rates were high and arranged marriages common. Family patriarchs approached marriage and reproduction with the same discipline that they approached any other business. The Rothschilds were the maestros of arranged marriages — the five branches of the family in different European countries married each other to keep the wealth in the family and solidify business deals — but you can find versions of the same dynastic strategies across the business world.

Today, the twin pillars of the old order are eroding. The birth rate is below replacement level in much of Europe and large parts of Asia. The Chinese birth rate has fallen still further since the end of the “one-child” policy in 2016, from 1.8 in 2017 to 1.09 in 2022. South Korea’s fertility rate fell from 1.1 in 2017 to 0.8 in 2022. Love-marriages are growing in popularity across the world, despite the potential problems that they bring in terms of ill-considered decision-making and talentless, indolent in-laws. A few places still retain the old ways: Some 60% of marriages in India are still arranged, and many Arab business families have a superfluity of heirs thanks to plural marriage. But even in India the fertility rate has fallen to 2.05 births per woman, and mores in the Arab world are changing fast.

The heirs that remain are much less inclined to follow their fathers into the family business. The brightest ones go off to elite universities and business schools and frequently put down their roots in big cities. The less talented ones who stay at home may be willing to take over the company but are often not up to the job. Two other demographic factors compound the problem of the shortage of heirs. Patriarchs and matriarchs now live much longer and may not be willing to concede control until they are in their seventies or even beyond. Divorce is much more common, so heirs may have divided loyalties and complicated relationships with their fathers and mothers.

Morten Bennedsen, an authority on family companies who teaches at the University of Copenhagen and INSEAD in France, says that he frequently encounters family heirs who are in agony: They don’t want to disappoint their parents (who have given them the best educations money can buy), but they don’t want to go back to running their family businesses. This is particularly true of heirs whose businesses are in remote parts of their native countries but who have been introduced to a cosmopolitan lifestyle from an early age.

The greatest novel about family businesses is Thomas Mann’s Buddenbrooks (1901), which tells the story of the decline and dissolution of a company in Lubeck due to a combination of bad business decisions and disappointing heirs. Research from the IFO Institute and the Foundation for Family Businesses, both based in Munich, demonstrates that the “Buddenbrooks problem” is becoming systemic in Europe’s most important economy.

The generation that built Germany’s Mittelstand companies into powerhouses is beginning to retire: One IFO/FFB survey found that 43% of German family businesses are due to transfer control or shares to an heir. Another survey found that that only 42% of family businesses do not have an heir lined up from within the family. A third found that only 34% had succeeded in managing a transition within the family in recent years, and only a quarter had managed to find a family member to sit on the supervisory board. The overall impression is of a collapse of dynastic energy: ageing owners, a shortage of willing or able heirs, poor succession planning, reluctant handovers to professional managers or forced sales to outsiders.

China also faces a severe succession problem. The problem is not as far advanced as Germany’s: China’s entrepreneurs only got to work building the country’s economic might in the 1980s. But if anything, the problem will be bigger. The one-child policy has simultaneously reduced the supply of available heirs and given them a dangerous sense of entitlement. Many of these little princes and princesses were educated abroad (or continue to live abroad) while the companies that produced their wealth are based in obscure parts of the country and specialize in unglamorous and often dirty businesses. Who wants to inherit an oil-processing plant in Mongolia when you can live off the interest in Mayfair?

Other prime candidates for Buddenbrooks syndrome can be found in many places. The Italian economy is dominated by family companies, but the fertility rate in 2020 was 1.24 per woman. The Parsi community is India’s most business-friendly ethnic minority, claiming three out of the country’s top 10 billionaires, but, thanks to persistently low birth rates, there are only 70,000 of them left. (Tata Sons Pvt. Ltd., India’s biggest company and a Parsi stronghold, has long since run out of Sons and is controlled by a foundation.)

Does the shortage of family heirs matter? And if so, is there anything that can be done about it? Randall Morck, of the University of Alberta, points out that the best performing firms are founder-controlled firms, followed by professionally managed firms followed by heir-managed firms. So why not let corporate evolution take its course and bring in professional managers to run the company? Or sell out completely and live off the interest?

There are numerous answers to this: Family firms have a longer-term perspective than professionally managed firms; they have deeper roots in local communities; they thrive in areas that require “taste” such as luxury and newspapers; they represent repositories of skills that have been built up over generations; and, in an age of collapsing trust in capitalism, family companies are trusted more than other forms of companies. Wolfgang Munchau’s Eurointelligence blog even speculates that the shortage of heirs might help to drive Germany’s deindustrialization because the Mittelstand companies have played such a vital role in investing in the country’s industrial infrastructure, even if it means enduring lower profits in the short-term. But their most persuasive reason for being relies on the case for pluralism: The wider the range of corporate forms available the better. If family firms can harness the natural desire to build a legacy for your children to business creation, then so much the better.

There are three clear ways to improve the possibility of a successful succession. The first is to go back in time — re-create arranged marriages or invent clever ways of keeping talent within the family. The University of Alberta’s Morck has produced fascinating research on how Japanese companies have a long tradition of adult adoption. Patriarchs who don’t think their children are up to the job adopt a high-flying employee. Firms run by adopted heirs perform better than both firms run by blood-related heirs and firms run by professional managers.

The second is to use modern management techniques to improve the chances of finding a successful heir. Claudio Fernandez-Aroaz, a Harvard Business School professor who worked for the executive search company Egon Zehnder for many years, argues that family patriarchs need to break with their old habit (notably fixating on their eldest sons) and think more imaginatively on family succession: Include all the children in the search for a successor and focus on competences and promise rather than on the narrow metric of experience.

The third is to pick and mix different elements of professionally managed and family-managed family companies. Families can continue to be involved with “their” companies without a family member taking over as CEO. Family members can exercise influence in all sorts of less direct ways — by sitting on boards (or supervisory boards in Germany), by choosing board members to represent their interests, by keeping a close eye on the professional managers they hire, or by having a few members of their family working for the company in lesser positions. Mario Daniele Amore, of HEC Paris, points to an interesting trend in Japan, a country leading the way in dealing with the low-fertility future: Family firms hire a non-family CEO for the short-term until the controlling family can identify a suitable family successor.

The first suggestion is not as eccentric as it might sound. The future belongs to those who show up for it: A growing proportion of the next generation will be made up of members of religious minorities such as Hasidic Jews or conservative Christians who have large numbers of children. The Hasidic population of Israel is set to increase from 13% today to 15% by 2050. These groups tend to favor both arranged marriages and family businesses.

Chinese families are going some of the way toward the Japanese adoption model by broadening the pool of family successors to include uncles, cousins, and more distant family members. Executive search firms also report an uptick in requests, particularly in Asia, for them to find suitable wives or husbands for designated family heirs. Surely a market exists for a hybrid of LinkedIn and Tinder for the inheriting classes.

Still, a combination of two and three is more likely to find favor with today’s cosmopolitan business heirs. Family companies already have one important demographic change on their side to compensate for all the negatives: Women are now routinely considered to be fitting heirs. This is particularly striking in Asia where women are more likely to rise to the top of family companies than they are to rise to the top of professionally managed companies or consultancies. Janmejaya Sinha, of the Boston Consulting Group, points out that women play a prominent role in some of India’s flagship family companies: The founder of India’s biggest soft drinks company, Parle Agro Pvt., has handed over management of the company to two of his three daughters, while the founder of a leading hospital chain, Apollo Hospitals Enterprise Ltd., subcontracts much of the management to his four daughters.

A more flexible approach to what makes for successful family involvement, including sitting on the board or mentoring professional managers, will add another advantage. The spirit of Buddenbrooks hangs heavily upon the family business world, not least in Germany and China. Yet with a combination of clever management, subtle thinking about what we mean by the “family” and enthusiastic mixing and matching of company forms, we can keep the spirit of family business alive even in a world in which the birth rate is falling and young people insist on marrying for love rather than corporate advantage.