Podcast: Institutionalization of Family Firms — Claudia Zeisberger, INSEADClaudia Zeisberger
The question seems simple: How Can Family Firms Ensure Long-Term Value Creation?
But as a new report – based on interviews 123 Asia-based family firms and 14 private equity professionals – shows, the answer may be more complicated.
The report is titled “The Institutionalization of Family Firms,” and it covers a significant driver of the global economy. As the study notes: “As family firms account for 70% of GDP in the global economy and 60% of global employment, the importance of long-term value creation extends beyond individual families – it is among the main drivers of economic growth and business innovation, as well as livelihoods.”
To understand the study – and the lessons it reveals – I spoke with the lead author, Claudia Zeisberger. Zeisberger is the Senior Affiliate Professor of Decision Sciences and Entrepreneurship & Family Enterprise at INSEAD, as well as Founder and Academic Director of the school’s private equity center. She is also co-author of the two recently published books: Mastering Private Equity & the accompanying case studies Private Equity in Action.
Among the topics we discussed: the so-called “Proficiency Gap” around Corporate Governance & Leadership; Access to Capital; Organizational Design; and Growth Capabilities. We also discussed the role private equity can play in helping institutionalize a family firm and unlock value.
Here’s a transcript of the conversation:
Chris Riback: Today I wanted to talk with you about your report, the Institutionalization of Family Firms and let’s make sure that everyone’s talking about the same thing. How do you define family firms?
Claudia Zeisberger: Family firms are enterprises that are controlled or run by family members. We have basically a clear measure that allows us to say whether it is a family firm or not. We look primarily at the ownership side.
Chris Riback: Tell me then about the survey, the research that you did, was there any size of firms that you looked at? How did you conduct the survey? And did you have a hypothesis going into it?
Claudia Zeisberger: Yes, that interesting. We basically went into this together with our colleagues at INSEAD’s emerging markets institute and supported by some of the private equity firms that we also interviewed then in the context. The initial premises where we wanted to find out what makes a family firm in Asia grow or not grow. What helps them to create value and create value remain a successful business over generations. We said this would be an interesting question to ask across the world but we wanted to start with one region where we have seen incredible growth in not just in the economy but particularly in family run businesses and that was Asia. We defined Asia all the way from the Middle East, including Australia as well. We said, what actually makes those firms grow? What are some of the obstacles there they’re hitting as they’re growing? And for those that are already at an advanced stage, when they look back, what do they wish they had had at certain critical points and into conjectures in their growth?
The premises were that to grow a family firm, institutionalization is critical. What we mean by that in simple terms is you need to move away from a pure family managed team. You need to bring in professional help. You need to bring in, you need to professionalize the whole institution.
Chris Riback: That’s the core of what the research shows and we’ll get into the data on that in some of your findings. What really interested me about that is it’s almost like, do folks gets caught up on the terminology and on the language because when one hears the term, uses the term family firm, the sense of a family almost by itself and by the nature of what that means might hint against a more formalized concept of institutionalization and yet it’s that blending of more institutionalization and more formality and rigor that you found drove greater growth and greater success. Just first, in terms of just the language that’s used, how did you find the family firms reacting to that? Reacting to the sense of institutionalization and more formalities?
Claudia Zeisberger: I have to say, most of them knew exactly what we were talking about. Just again, back to be clear, we interviewed families all the way, family firms run by the first, second, third generation, all the way to fifth generation and above of family firms. And obviously pending on where the family was across this spectrum we had quite different reactions to the questions we were putting towards them. I would argue the further along the family was, the better an understanding they had in terms of what we were talking about when we said institutionalization. Clearly, they had realized that they had hit at one-point certain roadblocks and had to basically overcome that by bringing in additional talent. A talent that could not be found within the family members.
Chris Riback: Why does, let’s talk about it and what you found particularly from the firms that were further along in that timescale, in the generation scale, why does institutionalization matter for family firms in Asia? What are some of the reasons or the ways that that helped them outperform or certainly perform better than the firms that don’t have the institutionalization?
Claudia Zeisberger: Doing business in Asia, and that probably applies to other emerging markets too, is complicated. It is less certain. You have potentially more political risk. There are certain areas that would be more corruption. There may be less regulation. You may have issues just simply with the rule of law. For example, a simple example, bankruptcy laws or just simple courts, institutions to go to if and when things don’t go as they were planned. You may even say that as an economy we have less digitization here so it is really more complicated business environment. Just as a side comment, I hear that as well from the private equity firms.
Asia is different from Europe or the United States in terms of doing business. Then the institutionalization matters because in such a difficult business environment you need to basically counteract that with more governance, within your institution. Nevertheless, when you’re a young business, when you are in first or second generation, very often what we found that the corporate governance framework is very much underdeveloped. You may have boards that are not as functional, you may have very much concentrated decision making or as we call it, group think in boards that are not as diversified. There may be less process, less data driven decision making, more intuition, more intuitive decision making. The economic priorities at times may take a backseat to the priorities of the family. That basically all ties into together with institutionalization.
Then comes the next step and that’s something that’s very close to the heart of any external investor, private equity or strategic would be professionalization. It matters particularly that the leadership is professional, that you have the right talent in place and that the family members that are involved, are involved in the right area of the business where they add the most value. That often then, very quickly, especially in Asia, hits the very, very thin talent pool that we have here. I hear that quite regularly that we are looking for X, Y, Z to improve our company’s structure but it is really, really difficult to find those people. That is why institutionalization really matters. To put processes in place to overcome those constraints that one has in doing business in Asia.
Chris Riback: Couple of questions coming to mind. First, in terms of, for a family firm and the analysis on when or at what stage am I ready for institutionalization and that level of professionalism. I’ve gotten to a certain point through the means that I’ve done it, working together as a close-knit family, however it is that I’ve done it, and how do they know? Is it time based? Is it sized based? Assets under management? How should family firms think about when they should know, be looking in the mirror and knowing, I better think about changing things around?
Claudia Zeisberger: That’s a very good question. From what we saw, it’s either driven by external or internal developments. On the external side it may very much be very rapid growth, very rapid expansion. Demand for certain products and services that the business is offering that just cannot be fulfilled by the existing infrastructure. Very often the business may have grown very, very fast, may have expanded very, very fast but the foundations and not keeping pace or not holding up with it. And that’s when then things start to run not as smooth as they should so the wheels need some external grease.
The internal part is very much generational handovers. At the point when the next generation comes in and is the second, third or fourth, that’s when very often the conversations are being raised. Are we still running the business, is our infrastructure still doing justice to the business as it stands? Or have our foundations become not solid enough, not rigorous enough in comparison to the size of the business? A handover to the next generation or just simply the next generation coming in, reaching the age where they can be involved in the business side. Very often does bring the topic of professionalization and institutionalization to the table.
Chris Riback: I was really struck a quote of yours, full quote of yours, in the report that over 30% of Asia’s family firms will go through a generational change in the coming five years, not always is the next generation able or willing to step into the shoes of their elders. That’s a fairly critical evaluation, I would think.
Claudia Zeisberger: Yeah, it is but we also, you’ve got to see it in context. Let me give you an example and I’m thinking of five students that I had over the last four years in my class. Let’s put them all together into one student. Those are MBAs, they’re 29, 30 years old, had five years job experience, now coming and doing their MBA. Obviously coming from a family business in Asia, very much the parents are expecting that young graduate now with a newly minted MBA under its belt to join the family firm.
Here’s conversations that I’d quite regularly have. I’m coming from a family business, I went to, I did my undergrad overseas in the UK for example, I then went on to work with a multinational in Paris, in the US, I’ve come, for example, one example is from a design background and I worked with Amaze and some of the fashion designers in Paris, I speak French, English but obviously my background is Chinese. My father runs a very profitable business, which is a supplier to Philips so there’s no brand or anything involved but it’s very profitable but it is in a, what China would call, third or fourth tier city. I’m the only child and clearly expected to go back to that business and it’s just not what I’m interested in.
And then very often I get the conversation afterwards, “Do you think private equity would be interested in having a conversation with my father and with that business?” Which then obviously is becomes an interesting conversation in terms of deal flow for some of the private equity funds here in Asia. You have understand that a lot of the businesses here are very profitable but they’re just not very, call it glamorous potentially. They’re not aspirational for the young people. If you are young computer scientist you’d rather go and work in Silicon Valley or in Boston with one of the startups. You may want to go to Berlin and look into tech fashion, create your own app, start your own business. You really don’t want to go home and run your manufacturing business of your family in India and Thailand or in China. That’s the context.
Chris Riback: That’s the context. And apparently in addition to being a global expert on private equity, you are also required to be an expert in psychotherapy. That’s excellent. I’m sure that that part of your practice must be growing.
Claudia Zeisberger: I’m very clear about it, I’m very clear about what I understand, what I don’t understand and I tell my student that as well. I’m obviously quite happy to connect them with private equity firms for a conversation. If that is something but I always point out, I said, “Guys, this does not reduce the importance of the conversation you must have with your family because that is clearly step one. That they have clearly understanding that it’s you don’t have the ambition to come back to the business.” And very often we’re talking, China, regularly the conversation is around one sibling only available. But in other parts of Asia there may be three, four or five siblings available and then comes the conversation, I’m supposed to run the business but I really don’t want to, my brothers may not want to do that either. It is quite complicated, yes, the transition planning.
Chris Riback: Complicated and interesting, that’s part of what makes it, there’s so many different levels and dynamics and makes it more than just a, perhaps more than just a straightforward business transaction. Let’s go to another aspect of your report and the findings and the proficiency gap between what you call champions versus ascendants. First of all, help me with the definition on champions and ascendants and then what do you mean by the proficiency gap?
Claudia Zeisberger: In terms of data, when we started to approach families, we expected to have 50 to 80 works with us. In the end we had over 120 that participated in the survey which we’re very, very grateful for. That they spent the time with us. Obviously to make the findings somehow digestible for our readership we had to somehow group the data and what we decided is to define the champions as those that are in the fourth generation or beyond. Fourth, fifth, and sixth generation. The ascendants are family firms run by first, second or third generation family firms.
Chris Riback: And what’s the proficiency gap?
Claudia Zeisberger: Then basically we have, we use the survey framework uses very distinct attributes and measures that reach from family ownership and succession, intangible assets, all the way to access to capital, corporate governance and leadership, growth capabilities and organizational design. Those are the tests that we put the data set to. We then discovered that it was quite a difference between the family firms in the group of the ascendants and the champions. Just one very, very simple example, looking at board composition, something that’s very much top of the mind of families, especially as they go through generational transitions which we found actually corporate governance and leadership was in general a very, very large driver of this proficiency gap. 55% of our champions had a professional board. Meaning board that was diverse, had a certain number of independent directors and in general was structured in a way that you would expect a board to operate. For example, it had subcommittees that would meet on a regular basis and so on and so forth. 55% of our champions had a professional board versus 26% of our ascendants. That’s a pretty significant gap.
Chris Riback: To what extent did family firms have outside help in terms of this institutionalization and professionalization? Understanding how to integrate proper corporate governance, aspects, how to have a properly functioning board but also these other points that you raise that drive the proficiency gap that the access to capital, the organizational design, the growth capabilities. Did the firms that had those things, were they disproportionately working with private equity firms or were they somehow getting there on their own?
Claudia Zeisberger: We had basically, we had both. We had families that had clearly gotten to a very, very high level of institutionalization on their own. We have basically some case studies at the end where we share some of the obstacles that they met and how they overcame them. Nevertheless, private equity played a very important role in the process as well. Quite a few firms brought private equity shareholders, most of the time as minority investors. I should be clear about that as well. We’re talking growth equity rather than buyout. They brought them in with a very clear intent to help them to professionalize the business. Professionalize the business was reason number one to bring private equity firms in. And the second one was then unlocking growth. Help us to get to the next level, whatever that may have meant in the business. And then the third one was the management of succession. Help us in thinking through succession planning at this point, in that order.
Chris Riback: You spoke with, it was 14 private equity firms, is that right?
Claudia Zeisberger: That’s right, yes. We chose those private equity firms so not randomly selected, we chose them because we were very clearly aware that those were firms that had worked with family firms, that were consciously reaching out, making an effort to getting close to those family firms.
Chris Riback: How did their insights compare to what you heard from the family firms? Was everybody talking about the same elephant? Or did you hear problems described differently or challenges described differently from let say, the PE side than you were hearing them from the family firms side?
Claudia Zeisberger: Yeah, absolutely. The PE partners, language played a very large role. It’s spot on. Very often, especially as a minority investor, they felt they had to be very, very clear about their plans when approaching the family firms. About what they would do post investment. They had to be clear about their value creation plans, what would basically drive the development. They also had to be very clear to explain that their involvement in the business by the nature of the business model of private equity, would be only temporary. A conversation had to be had on future exits. What would those exits look like? How would the family firm achieve that exit? Did it mean working towards an IPO or public listing which then would make the exit of the private equity shareholder obviously significantly easier? Or did it mean working towards the involvement of a strategic? Which is a bit more complicated as strategics normally are not interested in minority stakes. It would have required of the family to release potentially more of their equity, of their equity holdings.
Chris Riback: When you spoke at the private equity firms, was there a range of approaches? Did a PE firm A approach their interaction and the ways that they helped family firms institutionalize differently than firm B, C, D or E? Or was there a spectrum? Or did everyone have the same general approach and then within that there might differences in capability and how well they do at it, but generally the same blueprint.
Claudia Zeisberger: The private equity firms obviously are quite different. Absolutely, especially with the specialization that we’re seeing now across the industry, the firms were all very, very clear what they can do for a family business and what they rather not do. They were from the get go, very clear who they wanted to approach and who they wanted to work with and in what capacity. In general, they clearly had, I would say, the broader framework was similar across the private equity firms. For example, it was very clearly focused on a what we call active ownership, an active ownership model which basically then very quickly focused on improving the governance structure in the organizations, which make perfect sense.
Just for the point of improving or enabling communication and the professionalization of the business as well. And then very quickly bringing very clear measures in. Here’s our plan, these are the KPIs that we need to drive and what can we use to clearly monitor whether we are in line with those ambitions? Whether we are on track or whether we’re falling behind and then to bring this back to the board to have conversations that basically allow you then to say okay, what can we do to get back on track if we’re falling behind. It was very, very clear that the active ownership model clearly had to, was clearly connected to the value creation at the end.
Chris Riback: What’s the feedback been to your report? Both on the family firm side and on the PE side?
Claudia Zeisberger: Well you’re getting a sneak preview. We’re launching it officially on Monday, next week. We’ve shared it obviously with our partners, also with all the families that contributed to the research and the feedback has been fantastic. Especially from some of the family organization like FDN and White PO that wanted to have an event to present the findings of the research but also to give the families a chance to question some of the findings. Because clearly the way we wrote it, we wanted families, whether they participated in this study or not, ultimately to read through the report and find themselves in there. To give them basically a tool that would allow them to say, “Yes, that’s how we are.” And then look at some of the case studies and some of the suggestions that came out of the conversation with our private equity fund and potentially have some, find some suggestions, find some ideas on how they can ensure that the business will continue to thrive in the future.
Chris Riback: I’m sure that the firms are very grateful for those insights, the ones that participated and the ones that didn’t. To the extent that any of us are willing and able to look inside ourselves and have straightforward conversations with ourselves. They might see some things that they’re doing well, I would hope, and maybe identifying some things that they wish that they could recognize that they ought to be doing better. I’m sure your insights were very, very useful. To close out, Claudia, you know that everyone’s always happy with what has been done but that’s never enough. People want to know what’s next. What’s next? You go deeper into this within that region? You mentioned earlier that you’re going to perhaps look at some other regions and maybe be able to draw out some cultural differences if they exist. What’s next for you in terms of this area?
Claudia Zeisberger: Next will be the rollout to other regions, very clearly. Once we had originally planned to do Europe next. We have actually quite a lot of interest from Latin America. This may very well be our next region where we do a similar study and then compare the findings with Latin America with the findings we’ve had from Asia.
Chris Riback: Well very, very interesting. We’ll wait for that. How long does that take? How long did this report take you to do? How long would something like that take?
Claudia Zeisberger: This report took us a solid six months to create. Partly also because we had significantly more feedback, more involvement of the families because you’ll appreciate you’re asking families to spend a significant amount of time to go through the survey and answer those questions. Whilst we felt we had good relationship with those families since we worked with them over the years, we were still surprised how many were willing to make the time and sit down with jobs it meant we had a significantly more data to analyze which obviously is fantastic for an academic institution.