Ownership structures for family firms: The benefits and challenges

In the dynamic world of family businesses, ownership is not static. Families must remain adaptable to ensure their ownership structure aligns with their evolving goals and challenges. Previous success with one model of ownership doesn’t guarantee continued success, and there’s a real danger that the next generation of owners in a family firm could struggle to emulate previous success if ownership models aren’t updated or revisited.

Approximately 10 per cent of family businesses survive to the third generation, and in the GCC, 75 per cent are currently owned and managed by the second generation.

The dangers for MENA and GCC family firms are clear. Sustaining the wealth of family members means there’s often overwhelming pressure on family businesses to scale and grow as fast as the family itself.

But what exactly is a family firm? Forty years on from a seminal study into the nature of family-owned businesses in the US – known ever since as the ”Three Circle Model of the Family-Business System’ – the definition of a family enterprise from two of the parties involved still stands today: “A family company is one whose ownership is controlled by a single family and where two or more family members significantly influence the direction and policies of the business, through their management positions, ownership rights, or family roles.”

Ownership models: what are they, and how do they work?

As the author of Harvard Business Review’s Family Business Handbook notes, “The lack of awareness that family business ownership requires a set of choices is perhaps the greatest … misconception in the field of family business.” Hybrid models and exceptions aside, the prevailing five common ownership models in family businesses can be distinguished between the following: the owner/operator model, a distributed model (the most common), partnerships, public ownership, and finally, nested models.

Understanding the ramifications, limitations, options and implications of each model, as well as their inevitable trade-offs, is a crucial factor for family enterprises to consider, especially in times of transition.

Most family-owned firms in the Gulf are SMEs, but some have grown into large multi-faceted concerns, covering insurance, retail, shipping and real estate.

Owner/operator model

By far the least complex of all models, this usually concentrates ownership on one or two individuals. For this model to function effectively, families must establish and agree on succession plans. And that entails agreement among all interested family members to reach a consensus and a decision that’s considered fair by all. It’s not always easy, but it’s possible if families keep in mind two things: the needs of the business, and the fact that the chance to pivot to a different ownership model always exists, if and when it suits the business.

Distributed model

In what is unarguably the norm in most family-owned businesses, the distributed model sees ownership passed down to most or all descendants, regardless of whether those descendants work in the company. And it’s usually the norm because assets are often tied up and not liquid. In addition, with a few exceptions, parents generally aim for an equal share of inheritance to each of their children, where possible.

That’s not to say this model can’t and doesn’t create friction and challenges; family members working inside the business often find it difficult to reach an agreement with those not involved on a day-to-day basis. Strategic direction and compensation are two common sticking points. As one GCC management consultant notes, “The transfer of control to a third generation means that a [GCC] company formerly managed by siblings with the same family roots is now controlled by cousins, with different ones. With more family members and consequently more bloodlines the likelihood of internal rifts and formation of family silos is increased.”

But those challenges aren’t insuperable – simple changes in policy between distributed owners that reflect and reward the efforts of those directly involved in the continued success of a family enterprise can often be agreed on because these incentives will ultimately lead to greater returns for owners outside of the business.

Partnerships

Under this model, only those involved in leading the business forward get to be owners. And only they benefit from the company’s success. This model works well for many family-owned enterprises, but the dangers of a lack of consensus among partners can sometimes lead to paralysis when it comes to big tactical or strategic decisions.

These dangers highlight the criteria for entry into the partnership and the need to form a consensus on strategic direction, the ability to pivot, and the need to keep ownership models under constant review. Even when circumstances generate significant conflict among family members and partners, family enterprises must understand that a business can be saved from being sold or wound up so long as families are prepared to consider the range of alternative ownership models.

Public models

The biggest challenge for owners operating under this model is keeping control of a business when they have little say in the company’s decisions. Why? Although there are two common practices in public ownership models, in both cases, hired professionals are brought in to run the family company under this model.

Family enterprises may be set up so that all or some of their shares are traded publicly. However, some family businesses treat corporate governance as though it were a public company, even when the shares remain wholly owned by family members. Typically, in these scenarios, the family owners have little say in the running of the business.

Public models usually suit family enterprises where there are too many owners who aren’t really interested in decisions around running a family business or for investment stages where the business might need outside capital.

Nested model

This model is known as ‘nested’ because family-ownership clusters nest inside larger groupings, separate branches within the same family split assets so that some are held separately, and some are held jointly.

Successful nested operations generally see the core family running the core family business. Large dividends are then funnelled out to the branches, and those nested branches can then spend those dividends creating or acquiring enterprises to form their business concerns outside of the core business of the family.

For that to work, the core family must run the core family business with profits high on the agenda and make sure that the core business doesn’t over-fund those branches at the expense of inward investment.

This model can often ease the conflict that may arise from differences of opinion on how shared assets are managed and tend to reduce the impact of conflict so that a family is less likely to fragment down conflict-drawn lines.

Pivot to a new model: a necessity for survival

 Moving to a new ownership model can release a family firm from a deep rut and can often help keep families together for the common good of the business and of the family.

But there’s no particular rhyme or reason to how family businesses move from one model to another; it’s not uncommon for large organisations to move from a public model to, say, a distributed model.

Those kinds of changes will affect corporate governance, business and legal structures and, of course, individual relationships within the owning families in GCC family firms, but it’s possible.

And sometimes, it’s essential for continued survival.

The writer is the head of Marketing and Communications at Meydan Free Zone.