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Jakarta Post

Family businesses need good governance, too

Chris Razook (The Jakarta Post)
Jakarta
Tue, November 15, 2016

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Family businesses need good governance, too A crane moves a shipping container in the container pool of a seaport in Qingdao in eastern China's Shandong province, Oct. 13, 2015. (Chinatopix via AP/-)

F

amily businesses have long proven to be the engine of growth for many economies around the world, and Indonesia is no exception: More than 95 percent of the country’s businesses are family owned, generating millions of jobs and playing a pivotal role in the economy.

In the Asia Pacific, the top 85 family businesses employ more than 3 million people and account for 4.3 percent of the region’s gross domestic product (Global Family Business Index, Center for Family Business, University of St. Gallen). In the EU and the US, roughly 85 percent of businesses are family run (Upton/ Petty).

However, family businesses often have short life spans with a mere 33 percent surviving the founder and an astounding 95 percent failing by the third generation, figures from the Family Business Network show. They often become victims of their own making, failing to prepare subsequent generations for the demands of a growing business and a much larger family network in many cases.

To cope with these challenges, it is high time for family governance to become part of the discussion around dinner tables in Indonesia. Such principles explain how family businesses should set up their governance structures, including the establishment of a well-structured board, a professional management team, sound control functions and proper shareholder and disclosure practices. They also introduce mechanisms to manage potential challenges within the family, such as family constitution, employment, succession planning, disputes and shareholding.

Numerous studies have shown that good governance can help companies improve performance through better decision-making, stronger risk management and enhanced efficiency; effective governance can also boost the confidence levels of potential investors and business partners, resulting in improved access to capital.

Through our investment work at the International Finance Corporation (IFC), we have seen firsthand the benefits of good governance in family businesses across all sectors.

Many Indonesian firms, such as Blue Bird Group, realize the business value in raising governance standards and have taken (or are in the process of taking) steps to do so.

As Indonesia undergoes rapid industrialization with an expected growth rate of around 5 percent a year, more and more foreign investment is pouring into the country; foreign direct investment rose 7.8 percent year-on-year to a record Rp 99.7 trillion in the third quarter of 2016. Foreign investors will want to seek trustworthy business partners and good governance will play a crucial part in their decision-making.

Investors will not only look at the governance of the business but also at the family’s role in it: What is the background of this family? Where did their money come from? How is the family involved in the business and how will it be involved in the future? This is where family governance — not just corporate governance — becomes a crucial part of the equation. The unique challenge for family businesses is one of sustainability: Their long-term success is tied not only to the fundamentals of the business but also to the family behind the company.

Common Challenges: Based on IFC’s own experience, common challenges afflicting many familyowned companies in Asia stem both from fundamental shortcomings in their corporate governance practices and particular issues relating to their family’s role in the company:

• Boards of commissioners comprising mostly family and friends.

• Poorly functioning boards that meet infrequently with ad hoc proceedings.

• Informal management structures with ill-defined policies and processes.

• Nepotistic employment practices with family members holding key positions regardless of whether they are qualified.

• Key-person risk and concentrated decision-making, typically with the founder or family patriarch

• Lack of transparency outside (and sometimes even inside) the family.

The challenges for a family business will change as the company goes from generation to generation. For example, during the first or founder generation, the main concerns relate to core issues of succession and survivability. As the founder’s children take over, these concerns will have shifted to maintaining the family vision and ownership while integrating an increasing number of outsiders.

In the third generation, when there are often dozens of family members with some form of interest in the business, the challenges are more about managing disputes and family participation in the business while balancing the varied interests across the cousin confederation.

In general, Indonesian companies wishing to raise their family governance standards should:

• Address the corporate governance of the business itself, starting with a well-structured board of commissioners and sound control functions.

• Ensure succession planning for both family and non-family members is being adequately addressed by the board.

• Undertake measures to professionalize the management team, including merit-based employment and formal accountability and incentive mechanisms.

As a family, consider employing particular family governance mechanisms, such as a family constitution, family council and other key family policies to help govern the relationship between the family and the business.

Every company is different and will require its own practical approach to governance. Changes should also be done at the right pace based on business needs and what works for the company. For example, some family businesses opt for setting up an advisory board of select individuals who can provide strategic advice to the company, rather than making major changes to the composition of its board of commissioners right away.

Once they become comfortable with the advisory board and the way it functions, they would transform it into a full board of commissioners. Likewise, some family firms hire outside professionals to key executive positions such as CFO or COO as a way to test non-family members and strengthen the capacity of the management team.

Various tactics can be adopted over time to make the notion of having outsiders involved in the business more palatable for the family.

Once a family business brings in outside investors, improving governance practices, particularly in terms of board structure and shareholder practices, will become an imperative. Such investors, while placing faith in the family by investing in the first place, will naturally want to ensure that their interests are appropriately balanced with those of the family.

None of this needs to be onerous or daunting for a family firm. Practicality should prevail in such matters and improved governance will foster the company’s success for the next generation and beyond.

 

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