Why Do Family Owned Businesses Fail And So What?

The business environment in Western Australia (WA) has unquestionably shifted, and the fact that we at MVP are a lot more engaged in crisis management and strategic turnaround work lays testament to this reality.  Our view as highlighted in my previous article, ‘Are you flying blind?’, is that we think the business environment is going to tighten further before it improves. We therefore urge you, the Small-to-medium business (SMB) owner and manager to push pause and take a close look at the vital signs of your business. Is your business showing signs of going into decline or are you already trying to manage your way out of a crisis?

This question obviously requires that not only is the patient hooked up and that you have an ability to measure key financials, other leading indicators, initiate cultural change and inspire people to a higher level of performance, but more importantly that you have an ability to determine between the causes and symptoms of decline and crisis, failing which how will you know what you are looking at and how to take the correct remedial action.

The relevance of this message is that by sheer numbers alone Family-Owned Businesses, or FOBs, dominate the world over, with 89% of all businesses in the USA being FOBs. Of the 2.3m privately owned Australian businesses, approximately 2.1m are FOBs, with circa 125,000 of these in Western Australia.

You might well ask, why are these statistics of any interest or relevance to me? The Australian Federal Government certainly acknowledge the relevance of the 2.3m privately owned businesses in its 2015-16 budget, introducing the $20,000 accelerated depreciation allowance, a 1.5% reduction in the tax rate for incorporated companies with annual turnover of less than $2 million, and numerous other relief measures, with the Government’s objective in introducing these measures quite simply being to stimulate Australian economic growth, given that about 40% of Australian GDP is produced by FOBs. Of further significance to the Australian Government is that FOBs, a term that can almost be used synonymously with private business, account for about 50% of all employment in Australia, and tend to be the net-positive employer in times of economic downturn, whilst their large publicly listed counterparts are aggressively cutting heads to prop-up their next quarter’s financial results.

At a business-owner level, my experience suggests that the official statistics which claim that circa 70% of people get into their own FOB for ‘lifestyle’ purposes are either incorrect or outdated. I would argue that a large percentage of people start their own FOB because they have no other choice and have to put food on the table. Those that did in fact start their FOB in search of a better, more autonomous, lifestyle invariably come face-to-face with a very rude awakening – owning and running a SMB is complex, many moving parts and often no fun at all, particularly when difficult times come knocking, as they are for so many at the moment.

The most relevant statistic in the message that I would like to convey today is that about 50% of all FOBs fail within their first five years of being established. Said differently, a number equivalent to approximately 15% of all privately owned businesses fail each year, these are however replaced by an equal number of new business formations each year. This statistic is of course extremely alarming, particularly if you own and run a FOB, and especially if you are now facing ‘more’ challenging trading conditions. The question I would now want to have answered is, why do FOBs fail and what can I do to avoid failure?

The ‘causes’ of decline and failure that I’ve chosen to focus on in this article are peculiar to the Western Australian environment we find ourselves in currently, and FOBs in particular. These are the causes we would suggest you pause to consider right now.

Generic Causes of decline and Failure 

  • Big projects gone wrong – We constantly advise our clients operating particularly in the mining and resources sector to carefully consider who they are doing work for, the risks associated with that party and to take care that the size of the transaction does not present undue balance sheet risk; 
  • Changes in market demand We’ve witnessed clients’ new business pipelines literally halve ‘overnight’ as upstream clients focus on cutting costs and unnecessary spending;
  • Increased competition – As the environment has become increasingly tough industry competitors are seeking to compete more aggressively, which is manifesting itself more and more in lower prices to the customer, to the point where some of the work being done is no longer profitable, but simply keeps the cash flow cogs greased. The potential effect of this is industry structural change which can impact on otherwise healthy participants;
  • Poor marketing – Our view is that your marketing and sales strategy must flow from your over-arching corporate and business strategy. With over 74% of FOBs reportedly not having a formal documented strategic plan, logically how can one have a well-considered strategic marketing and sales plan. Furthermore, businesses are notorious for cutting their marketing and business development budgets when times get tough, when in fact this is exactly the time that businesses should be ramping up their marketing and business development activities in an effort to secure a greater share of customer spend in a diminishing market. The big question in this regard is of course – how? Furthermore, many would argue that it is extremely difficult to determine what marketing dollar spent resulted in success. There can of course be no disputing that this is a very challenging subject, which most business owners tend to shy away from, however, there can equally be no disputing the essential need to get into the market place to actively compete for additional and new customer business, particularly in this current environment where the amount of business is far less than what it was a few years ago. As a starting point we always advise our clients to commence this process with what we refer to as a ‘relationship marketing’ initiative. This in simple terms is a marketing strategy focussed on your existing customer base, those with whom you have done most of the hard work already and hopefully established a relationship of trust and understanding already – A book that I highly recommend you read in this regard is ‘The new Rules of Sales and Service, by David Meerman Scott’;
  • High cost structures – Through the ‘fat years’ of the mining boom many business owners achieved considerable growth and prosperity in spite of themselves. Now that the ‘lean post mining boom years are starting to bite’ business owners have to step up decisively and make every effort to make their businesses more efficient, productive and capable of running on far lower costs structures. This statement is way easier said than done as this discipline almost always involves a reduction in headcount, an extremely confronting task for most clients we deal with. If you know that you are going to have difficulty in identifying excess costs within your business’ cost structures, and once identified you are not going to be able to make the hard decisions, our advice to you is take action now and seek some cold-blooded independent help to step you through this process, and importantly keep you focused on the desired outcomes. If you are not making enough revenue and your cost structures stay too high it would seem only a matter of time before failure comes knocking at your door;
  • Poor financial policy and management – It never ceases to amaze us that we encounter business after business, some with revenue well in excess of $5m per annum, which do not have budgets, P&Ls, balance sheets, cash flow statements and management accounts in place. Good business strategy and well run successful business’ dictate that a business’ financial performance must be accurately measured according to pre-determined financial ‘Key Performance Indicators (KPIs)’ and monitored and reported on in detail at leadership level. In new client engagements we always go straight to the numbers, and immediately start putting all of this in place. The results are tangible and have an immediate positive impact on the business. Of course one cannot make financial geniuses of all business owners and managers overnight, and this is most certainly not the object. The objective must firstly be to bring structure, focus and policy, and then over time to transfer valuable knowledge through a process of active on-site business coaching;
  • A lack of leadership – Please make no mistake, management is not leadership and leadership is not management. Notably, my experience would suggest that you will seldom find outstanding leadership and management attributes in the same person, this is a rare beast. Furthermore, I have seldom encountered business people in leadership positions who have the experience, skills, maturity and wisdom that affords them the ability to seamlessly transcend one leadership style to the next as required by the circumstances. The required leadership style in prosperous times is very different to that in very difficult times, a toxic culture in need of repair demands a very different leadership style to a healthy culture in a state of flow, and then the nature of staff member and the nature of work will in-turn again demand a very different type of leadership style. Early into our new client engagements we always assess the business culture and team dynamics in the context of the environment and circumstances the business finds itself in, reconciling this to the leadership style in evidence. Our advice to you would be to carefully consider your leadership style in the context of the issues your business is currently dealing with and in the context of your team objectives – is this the appropriate style for the circumstances and are you leading and inspiring your team towards the ‘desired outcomes’?
  • An inability to cope with change – It simply cannot be any clearer, the business environment in Western Australia has changed significantly, and is continuing to change quite rapidly. I don’t mean to be an alarmist , however one must have an ability to see reality for what it is and deal with it quickly and decisively. We always tell our clients that in business you only have a few levers you can pull on in an effort to achieve better financial performance – Sell more, increase price, lower cost of sale, lower indirect operating costs, change capital structure. Of course within these simple words is a huge amount, not least of all an enormous debate about business model innovation and optimisation. The point is you must quickly come to terms with what is happening, and what is likely to happen, in your business environment, and have an ability to first identify the correct lever to pull and how to pull it. Importantly, change which is a constant, to quote a trite cliché, requires that action is always taken to cope. Strategy is constantly about moving from point A to point B, you cannot stand still; and finally on this subject
  • Poor cash flow management – This simple fact comes as a surprise to so many business owners and managers – Profit after tax is not ‘free cash flow’. Because your business is showing a monthly profit please don’t think that automatically equates to cash in the bank you can spend as there may be provisions and commitments against that cash. In challenging times, more than ever, we advise our clients to focus on cash management, monitoring and control. In good times cash seems to pour in, in tough times it seems to not be able to come fast enough. In times like these we always advise that business owners put in place a 4 to 8 weeks rolling cash flow forecast, or longer if that level of visibility is possible, and that you monitor expected cash receipts and commitments and reconcile this back to your P&L.

Within the topic of generic causes of decline and failure there are of course many other causes, however if I had to continue along this path this short article would quickly become to a short book. If you have a specific interest in this area please e-mail me and I will refer you to a few excellent books on the subject. However, let’s now consider Family Business specific causes of decline and failure.

Before I launch into some of the FOB specific causes of decline and failure I would like to hose down the impression I might be creating in this article that all FOB are doomed to failure. On the contrary it is reported that about 120 of Australia’s largest 500 privately owned business are FOBs. Furthermore, some of Australia’s FOB leaders are amongst the icons of Australian business, and far more prominent and successful than those in their listed company counterparts. If one looks internationally you will see that some of the largest and most successful companies in the world are FOBs. One can’t deny the fact that FOBs are a completely unique class of business entity, which in so many ways are far superior in my opinion to their listed counterparts. From my experience the most notable fact is that FOB owners and managers have a huge sense of purpose, and when the chips are down exhibit an almost super-human level of resilience and determination. I am always buoyed and humbled by this, and I can share that I learnt a long time ago to never say never to a FOB owner or manager, but rather to actively engage in a process of working through the ‘what-if’ in search of better options.

 

Family Business specific causes of decline and failure.

  • Death of the business founder – The death of the business founder and owner is reportedly the catalyst for 78% of FOB failures. We often see that when the business founder lives to retirement age he or she becomes increasingly reluctant to face his or her own mortality and enter into a structured process of handing over the reign, leaving the family in a crisis at death; 
  • Failed family relationships and conflict ­– In my opinion there can be no separating the FOB from the affairs of the family, with this situation becoming more complex over time. FOB owners and leaders occupy the unenviable position of being what I refer to as mega-structure leaders, which encompasses the FOB, family and the FOB leader or manager. These three separate but intertwined systems come together to form a cocktail of very complex dynamics, which may often manifest themselves is incompetent family member employees, spoilt kids in the business, entrepreneurial inter-generational aggressions, altruism, marital conflict and a tendency towards autocratic rule. It is only through considerable experience can one hope to navigate and advise clients through this very complex quagmire; 
  • Intermingling of finances – Reportedly two thirds of FOBs intermingle family and FOB finances, and at times it is very difficult to distinguish between the two. The significance of this is that firstly, this makes it extremely difficult to accurately measure and monitor the financial performance of the FOB, and secondly this may in fact be catastrophic for the family and the business. We always advise clients at the outset to consider their business entity ownership structure, and to structure this in a manner that takes into account potential risks and how to best mitigate these. Quite obviously, FOB and family finances should be separated to the fullest extent possible and furthermore, family assets should be removed from FOB risk to the fullest extent possible. This is a complex subject best engaged as early in the process as possible as over time it becomes increasingly difficult and costly to implement. In this environment, and particular if your business is experiencing difficulty in this environment, we would suggest that you pause to consider your FOB-Family ownership structure and potentially take advice to see what might be done to ring-fence, mitigate and remove or distance risk; 
  • Scarce financial resources – Most, but particularly early stage, FOB have access to limited financial resources and lines of credit. The large majority of FOBs we work with have self-funded their businesses, and in many cases continue to do so out of family assets and the family home mortgage. In a declining business environment significant strain may be put of these limited financial resources, and it is important to bear in mind that banks will go only so far and no further. We advise clients that it is therefore very important to understand the limit to these scarce resources and to clearly identify at what point in the future that limit might be arrived at. So many clients that come to see us for help in this area have quite simply left it far too late and there is very little, or nothing, that can be done for them. The statistics suggest that 70% of businesses that attempt to turn their performance around fail, for this and other reasons. We find that for those FOB owners and managers that are slow to take action and embrace essential change what tends to jolt them into action is when we clearly set out in front of them what is at stake, this most often starting with the potential loss of the family home should the FOB fail. We would recommend that FOB owners see beyond personal funding and bank debt when considering funding options for their businesses and furthermore, should you wish to explore shareholder equity as an potential funding option please cast your mind beyond ordinary voting shares as the only instrument at your disposal. This is a very involved topic which must be dealt with by a very suitably qualified and licenced advisor; and finally on this subject 
  • A reticence to call in outside help – I read a long time ago that about 63% of male university leavers wanted to start their own businesses, with their primary motivation being that they did not want to report to someone else. I suppose this ‘alpha-male’ syndrome is one of the reasons that even when the chips are down certain FOB male owners and managers cannot bring themselves to call in outside help. I can share that on a few occasions I have been appointed to help turnaround a FOB in crisis and the FOB male owner has not been willing to listen and take guidance, making the exercise totally useless. Our advice to anyone in decline or crisis would be to call in a suitably qualified external adviser as soon as possible, don’t follow blindly, but engage and take advice.

If you would like expert help and support to improve the profitability and performance of your family run business, then speak to us today and arrange a FREE no obligation meeting.  Simply complete the form on the contact us page or the got a question form and we will be in touch shortly.

Download printable PDF – Why family businesses fail