Family Business Conference – Speech by Vince Farrugia, Director General

What is a Family Business?

Talking about family business may conjure up thoughts of small father and son firms but family enterprises form a backbone running right through the economy who are particularly prevalent in the micro business sector (firms with fewer than 10 employees) are also common in the rest of the small and medium enterprise (SME) sector.  Some of the very largest private companies are also family firms.

 Family firms vary significantly in size and differ in the degree of family involvement in the business.  Some families will take a role in the day-to-day running of the business, whilst others will take a more hands-off approach with the involvement of professional non-family managers.  Family firms range in terms of longevity from early-stage to long-standing multi-generational firms.

Precise definitions of a family business vary, but the firms should have to meet some criteria about their ownership or management.  A commonly accepted definition, as worded by "The Family Entrepreneurship Working Group" set up by the Finnish Ministry of Trade and Industry in 2004, is that:

• The majority of control is held by the person who established or acquired the firm or their spouses, parents, child or child's direct heirs.
• At least one representative of the family is involved in the management of administration of the firm.

In addition, and particularly to smaller firms, subjective criteria need to be employed in order to distinguish family firms from entrepreneurs in other owner-managed firms more generally.  Most obviously, the firm itself can be asked whether it considers itself to be a family business.

Characteristics of a Family Business

Ownership typology

The tightest control is in owner-managed firms, which are owned by a single person who is also the only managing director.  Sole-traders are therefore owner managed.  Bigger firms are more likely to be family-managed, where the ownership and management is in the hands of at least 2 family members.  In family-controlled firms, the family takes a more hands-off approach and the management and/or ownership is shared with non-family members.  The family remains in full control of the company, however, by holding a significant proportion of the voting rights.  The largest family firms will be family-controlled.

For small and medium-sized firms, around 40% are owner-managed, 45% family-managed and 15% family-controlled.

Sectoral concentration

Family firms are particularly prevalent in agriculture and construction and retail and services.  Within the services sector, family firms are most likely to be found in distribution, hospitality, catering and tourism.  They are under-represented in sectors such as finance, manufacturing, banking, telecommunications, insurance and business service.  This no doubt reflects the high start up costs involved in these sectors.

Generational Transfer

A sample survey by GRTU found that 77% of family firms in the SME sector are controlled by the first generation, 10% by the second generation and 6% by the first and second generation.  Only around a third of family firms tend to be passed onto the second generation and one tenth reach the third generation, the rest being either sold or closed down. 

Surveys elsewhere show that the bigger – and probably older- the firm, the more likely that it has already been passed onto future generations; family firms in the SME sector with at least 10 employees are twice as likely as those with fewer than 10 employees to be controlled by the second generation.  The generation of ownership also varies by sector, with agricultural businesses most likely to be controlled by the second generation.

Our survey of family firms suggests that most have no definitive plans abut what to do with the firm in the future, with 61% of owners saying they had made no decision about what would happen when they stepped down from the helm.  Of the remainder, 16% had already decided on a successor, 13% planned to sell the business, while 10% planned to close it down.  Last year our survey showed that 19% of respondents intended to sell or transfer the business in the future.

Executive Summary

We estimate that family firms account for 85% of the private sector enterprises in the economy. The vast majority of family enterprises are small and medium enterprises (SMEs).  56%are sole traders with no employees.  We also estimate there to be over half the firms with over 250 employees are also family owned.  These alone account for 20% of the turnover of the overall family business sector.

Because family enterprises are more likely to be small firms, they account for a lower share of turnover, employment and GDP than of the total number of firms in the economy – but the share is still substantial.  Family enterprises produce around 45% of turnover in the private sector.  We estimate that they also account for around 40% of GDP in the private sector and 38% of GDP in the overall economy.

Their share of employment is slightly higher, given that small firms tend to employ more people per unit of output than large firms.  We estimate that family businesses account for around 45% of private sector employment, providing employment to 60,000. The contribution of the family business sector to the economy extends beyond its direct contribution to output; it also acts as a crucial breeding ground for entrepreneurial talent and start-ups. Furthermore, we estimate that family businesses pay around 25% of the Government's total tax receipts.  If we include taxes paid by employees of family firms, this raises the contribution to tax revenues 35% of the total.

Meanwhile, there are good reasons for family firms to be more profitable and stable than other firms.  Perhaps the biggest advantage lies in aligning the interests of managers and owners.  Family firms also tend to have a longer time-horizon than other firms.

The business and tax environment has generally been supportive of family business.  However, further progress could be made in the development of a more favourable tax regime through extending the scope of business property relief and protection of business asset holdover relief.  Measures to improve the succession rate of family firms when it comes to passing the firm on from the current generation are also needed.

Some Statistics

• Entrepreneurial activity is about 6 to 8%of the adult population
• They usually establish businesses that are more than 50% family owned. About a third would be businesses that emerge from other family businesses
• About 10% of the population own or manage a business
• Family based start-ups use the amount of initial finance compared with non-family start-ups and are more likely to approach close family for their start-up finance than those who do not have a family base.
• Levels of self and family ownership are significantly higher amongst established business owners than early stage start-up entrepreneurs. 67% are owners of more than 50% of their business.
• The level of self and family ownership are significantly higher for women than for men, 75% compared to 60%.
• Significantly more early stage entrepreneurial activity emerge from existing family businesses than for owner managed.

Finance: Sources

Government programmes are used less by family firms and family businesses – do not feel government is interested in financing family businesses.

Advantages of Family Businesses

• Family firms might be a positive force when it comes to performance of the private sector in terms of productivity and profitability. Research has shown that family owned businesses tend to perform better because they better align the interests of managers and owners and better incentivise managers to achieve the firm's goals. Managers tend not to pursue their own interests to the detriment of owners' interests as happens in non-family owned firms.
• Family members working for the business will stay longer than staff of non-family firms and gain more firm-specific expertise and lower the productivity losses of high rates of staff turnover.
• Family firms take corporate social responsibility more seriously. They tend to be small firms and build local relationships and good will with suppliers and customers.
• Family firms tend to have a more flexible approach to management and use a centralized decision process to enable quicker decision-making.
• Family firms tend to be more willing to wait longer than most other investors for a return on capital invested.
• Family businesses are more prepared than other firms to continue investing during cyclical downturns giving them an advantage on other non-family firms who tend to follow cash flow more closely.
• By offering more flexible working practices family firms access to a wider pool of labour than other firms. This has the added bonus of boosting diversity of work practices.
• Family firms tend to enjoy more loyalty from staff members who are motivated to build up the family brand name. Loyalty to the firm tends to be more long lasting.
• Family firms are more likely to invest for the long-term and focus on long-term returns rather than quarterly results.
• There is evidence that families tend to draw smaller salaries and dividends allowing more profits to be re-invested back in the business.

Problems Faced by Family Businesses

• Recruitment from family narrows level of skills.
• Nepotistic recruitment strategy discourages talented people. Survey by Price Waterhouse Cooper in UK showed that only 22% of family firms have established criteria for choosing family members.
• Reluctance to bring in outsiders as non-executive directors hamper use of external knowledge.
• Family firms may lack professionalism and be reluctant to change and embrace new technology.
• Reluctance to change management styles or strategies and fail to adapt to market change.

Problems Could….

• Family conflicts such as marriage separation and infighting might disrupt the business.
• Reluctance to dilute control may hamper family firm's growth
• A family firm might suffer from a conflict between financial and non-financial objectives (eg. Lifestyle enhancing)

Do these disadvantages outweigh the advantages?

Let's say research shows that family businesses do at least as well as non-family businesses.  But there is evidence that family businesses perform better: a study in the 1990's conducted by the London Business School showed that over a 20 year period family controlled businesses on the stock exchange outperformed the overall index by nearly 30%.  A survey by Thomson Financial in 2005 showed that family firms outperformed across Europe.  The Manchester Business School Family Business Index of publicly quoted family firms, outperformed the FTSE All Share by 40% over 1995 to 2005.

One particular issue that is bothering many families as many    who went into business as the Maltese economy leaped forward during the seventies is that of succession.  Many business owners are ageing and the issue is greater as their sons or daughters moved to other professions or opened their own, different lines of business.

Succession

Only one third of family owned businesses survive the transition to the second generation.

And of these businesses again only one third will survive to the third generation, meaning that the chances your grandchildren will take over your business are about 1 in 10.

Reasons:

• 1. There is no qualified successor
• 2. Businesses fail or are sold off due to lack of planning.
• 3. Main reasons are personal and family issues that preclude succession planning.

  Fear of Retirement

For most business owners their business is their single largest asset in terms of value, but it also represents a major source of self-esteem and personal worth.  Many owners simply don't want to think about the day when they will no longer be running the business.  The fear of retirement pushes succession to a question of the owner's death.

Our essential issue: how to pick our child to succeed while being fair to others.

Success Planning

This is an important issue (BDO Dunwoody: Succession Planning For Family Business)

Planning process:

• Determining whether business succession within the family is viable
• Develop your succession plan
• Monitor the implementation of the plan and make changes as necessary and coordinate succession plan with personal tax planning for retirement and the distribution of your estate
• Work to ensure that your succession goals for your business and those of the successor merge and don't just overlook one child simply because his/her goals differ from yours

Estate Planning

Succession planning leads to another important problem that needs to be resolved: estate planning as you need to ensure that the steps you take do not have a negative effect on your succession plan.

Issues Raised by GRTU Founders 60 Years Ago

• 1. Bureaucracy
• 2. Taxation
• 3. Unfair competition
• 4. Corruption
• 5. Port charges
• 6. Infrastructure/state of Rds
• 7. Access to finance
• 8. Stimulus to growth
• 9. Price of bread
• 10. Transport/bases
• 11. Electricity charges
• 12. Back payment by Government
• 13. Late payments

Central Issues Raised by GRTU Members: What Bothers You Today?

Issues:

• 1. Bureaucracy
• 2. Red carpet treatment?
• 3. General accounting principles
• 4. Simplification
• 5. Reduced administrative burdens
• 6. Government is helping so that you can focus on creating wealth
• 7. Fair taxation system
• 8. IPSE?
• 9. Access to finance
• 10. Risk management
• 11. Public regulators – MMA, MCA, MRA, OFT, Med. Authority (Labour department/ETC, OHS)
• 12. EU funding: €38 million
• 13. Working time
• 14. Waste management
• 15. Energy costs
• 16. Financial crisis
• 17. Bank charges
• 18. MIF charges
• 19. Late Payments
• 20. Money due for Government
• 21. Succession/Sell Out
• 22. Diversification
• 23. Internationalization

Way Ahead

• 1. More professionalism
• 2. We have to be there
• 3. Internationalize
• 4. Training
• 5. Innovation
• 6. Restructuring