Family businesses are the backbone of the American economy. In fact, 90 percent of the approximately 15 million businesses in the United States are considered to be family businesses, representing more than 60 percent of the gross domestic product. Some are mom and pop operations, of course. But some are the leading players in their respective industries. One-third of all the businesses in the S&P index are family businesses.

Eighty percent of family business owners want to keep the business in the family and pass it on to the next generation. Unfortunately, only one-third of family businesses make a successful transition to the second generation and only 15 percent make it to the third generation.

Given the scope of the family business industry and the statistical lack of success in transitioning family businesses to the next generation, one would think that a vast body of sophisticated business advice is available to family businesses, the way it is to large non-family businesses. Unfortunately, family businesses historically have been underrepresented in terms of quality advice. This is beginning to change. And scholars and consultants are finding that advising family businesses on strategy and succession is very different from planning for large, non-family business.

A recent report published by the giant consulting firm, McKinsey & Company, is a welcome addition to the literature on successful family businesses. The report, “The Five Attributes of Enduring Family Businesses,” published in the January 2010 issue of McKinsey Quarterly (www.mckinseyquarterly.com), identifies five key activities that large family businesses need to engage in to achieve strong business performance and to keep the family committed and capable of carrying on as the owner over a number of generations. The five attributes are: (1) harmonious relations within the family and an understanding of how the family should be involved in the business; (2) an ownership structure that provides sufficient capital for growth while allowing the family to control key parts of the business; (3) strong governance of the company and a dynamic business portfolio; (4) professional management of the family's wealth; and (5) charitable foundations to promote family values across generations.

Family

Family businesses can go under for many reasons, including family conflicts over money, nepotism leading to poor management and infighting over the succession of power from one generation to the next. Regulating the family's roles as shareholders, board members and managers is essential because it can help avoid these pitfalls.

Large family businesses that survive for many generations make sure to permeate their ethos of ownership with a strong sense of purpose. Over decades, they develop oral and written agreements that address issues such as the composition and election of the company's board, the key decisions that require a consensus or qualified majority, the appointment of the CEO, the conditions in which family members can (and can't) work in the business and some of the boundaries for corporate and financial strategy. The continued development and interpretation of these agreements, and the governance decisions guided by them, may involve several kinds of family forums. For example, a family council representing different branches and generations of the family may be responsible to a larger family assembly used to build consensus on major issues.

Long-term family businesses also share a meritocratic approach to management. There's no single approach, however, since policies depend partly on the size of the family, the education of its members and the industries in which the business competes.

As families grow and ownership fragments, family institutions play an important role in making continued ownership meaningful by nurturing family values and giving new generations a sense of pride in the company's contributions to society. Family offices can bring together family members who want to pursue common interests, such as community involvement, often through large charitable organizations linked to the family. The family office may help organize regular gatherings that offer large families a chance to bond, teach young members how to be knowledgeable and productive shareholders and vote formally or informally on important matters. It can also help keep the family happy by providing investment, tax and even concierge services for family members.

Ownership

Maintaining family control while raising fresh capital for the business and satisfying the family's cash needs is an equation that must be addressed, particularly in the transition of power from one generation to the next. Family businesses that endure tend to regulate ownership issues — such as how shares can (and can't) be traded inside and outside the family — through carefully designed shareholders' agreements (also known as buy-sell agreements) that typically last for decades. The primary purpose of these agreements is to restrict the trading of shares to keep the ownership of the business in the family. In a cross-purchase shareholders' agreement, family members who want to sell must offer other family members a first right of refusal to purchase the shares. In a redemption shareholders' agreement, it's the corporation that's given the first right of refusal. Whichever approach is used, payouts are usually long-term to avoid decapitalizing the business or discouraging other family members from purchasing the shares.

Governance and the Business Portfolio

Large and durable family businesses tend to have strong governance. Members of these families participate actively in the work of company boards, where they monitor performance diligently and draw on deep industry knowledge gained through a long history.

Although family involvement is crucial to long-term success, it's also very important to complement the family's knowledge with the fresh strategic perspectives of qualified outsiders. Even when a family holds all of the equity in a company, healthy boards will most likely include a significant proportion of outside non-family directors.

Successful large family businesses spend the time to attract and retain outside talent to the board and key executive positions. In this respect, they have a handicap compared to their non-family peers, because non-family executives might fear that family members make important decisions informally and that a glass ceiling limits the career opportunities of outsiders. Successful family businesses can overcome these obstacles by emphasizing caring and loyalty, which many talented people see as value above and beyond what non-family corporations may offer.

In addition to good governance, successful large family businesses usually seek steady long-term growth and performance to avoid risking the family's wealth and control of the business. This approach tends to shield them from the temptation — which has recently brought many corporations to their knees — of pursuing maximum short-term performance at the expense of long-term company health. A long-term planning horizon and more moderate risk taking serve the interests of debt holders too, so large family businesses tend to have not only lower levels of financial leverage but also a lower cost of debt than their corporate peers do.

This long-term perspective may make family businesses less successful during booms but increases their chances of staying alive in periods of crisis and of achieving healthy returns over time. In fact, from 1997 to 2009, a broad index of publicly traded family businesses in the United States achieved total annual returns to shareholders two to three percentage points higher than those of the S&P index.

Nonetheless, too much prudence can be dangerous. Family business owners, who usually have a significant part of their wealth associated with the business, face the challenge of preventing an excessive aversion to risk from influencing company decisions. Excessive risk aversion might, for example, unduly limit investments to maintain and build competitive advantage and to diversify the family's wealth. Diversification is important not only for overall long-term performance, but also for control because it helps make it unnecessary for family members to take money out of the business and diversify their assets themselves. That's why most large, successful family businesses are multi-business companies that renew their portfolios over time.

Wealth Management

Beyond the family business holdings, families need strong mechanisms for managing the family wealth outside the business. By diversifying risk and providing a source of cash to the family in conjunction with liquidity events, successful wealth management helps preserve harmony. McKinsey recommends single and multi-family offices as the preferred wealth management solution for wealthy business owner families. The report identifies five key factors that increase the success of family wealth management offices: (1) a high level of professionalism; (2) institutionalized processes and procedures; (3) strict performance management; (4) a strong risk-management culture, with aggregated risk management and monitoring; and (5) thoughtful talent management.

Foundations

Finally, the McKinsey report stresses the importance of philanthropy as a way of keeping families committed to the business, by providing meaningful jobs for family members who don't work in the business and by promoting family values as the generations come and go. Sharing wealth as an act of social responsibility also generates good will toward the business. Foundations set up by entrepreneurial families represent a huge share of philanthropic giving. In the United States, they include 13 of the 20 largest players, including the Bill and Melinda Gates Foundation.

Money alone doesn't guarantee high social impact. In addition to the financial and operational issues facing any charitable entity, families must cope with the critical challenge of nurturing a consensus on the direction of their philanthropic activities from one generation to the next. Some family foundations have tackled the issue by creating a discretionary spending budget allowing family members to finance projects that interest them. Others give family members opportunities to serve on the board or staff of the foundation or to participate directly in philanthropic projects through onsite visits and volunteering opportunities. This approach is an especially powerful way to engage the next generation early on.

Family foundations also face organizational and operational choices about how best to use their funds. Several have concluded that in today's complex environment, partnerships with other nonprofits or nongovernmental organizations can promote the family's social goals. These foundations build on the experience and local presence of other organizations, particularly when implementing projects in unfamiliar geographies.

Finally, to encourage high performance and continual improvement, family foundations must combine passion with professionalism and a strict assessment of their impact. Although assessing impact is difficult, it's vital to make progress and allocate resources effectively. The report recommends that family foundations focus their monitoring and evaluation efforts around learning and improving decision making. They must also approach operations with a mindset of an investor — minimizing operating costs and making prudent investments in strategy, planning and evaluation as well as in highly qualified staff.

The report ends with the cautionary advice that only those family businesses that master the challenges intrinsic to this form of ownership endure and prosper over the generations. The work involved is complex, extensive and never ending, but according to McKinsey, the evidence suggests that it's worth the effort for the family, the business and society at large.

SPOT LIGHT

Perseverance

Bob Kuhn's “Aquacade,” painted in 1974 with acrylic on masonite and measuring 24 inches by 40 inches, sold Sept. 18, 2010, for $225,000 at the Jackson Hole Art Auction in Jackson, Wyo. Kuhn has shown true creativity as an artist by painting representations that take viewers into the very midst of nature's places, almost into the minds of the animals themselves.