14 Reasons why family businesses fail

Doug Verley
Feb 16, 2017
Business
8
minute read

The business environment in Western Australia (WA) has unquestionably shifted, and the fact that we at Here Business & Wealth are a lot more engaged in crisis management and strategic turnaround work lays testament to this reality.

The view, as highlighted in the previous article, ‘Are you flying blind?’, is that the business environment is going to tighten further before it improves. Family businesses need to pause and take a close look at the ‘vital signs’ of their business. Is your business showing signs of going into decline? Are already trying to manage your way out of a crisis?

This question requires an ability to measure key financials, leading indicators, initiate cultural change and inspire people to a higher level of performance, but more importantly, it means you must have the skills to identify the signs of decline and its causes so that you can take remedial action.

The relevance of this message is that by sheer numbers alone, family businesses dominate the world over, with 89% of all businesses in the USA being FOBs, and of the 2.1m Australian businesses, approximately 70% are family businesses.

You might well ask, why are these statistics of any interest or relevance to me? The Australian Federal Government certainly acknowledged the relevance of the 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 to stimulate Australian economic growth. Of further significance to the Australian Government is that family businesses, 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claim that circa 70% of people get into their own family business for ‘lifestyle’ purposes are either incorrect or outdated. I would argue that a large percentage of people start their own business because they have no other choice. Those that do in fact start their business in search of a better, more independent lifestyle invariably come face-to-face with a very rude awakening – owning and running an SMB is complex, with many moving parts and often no fun at all, particularly when difficult times come knocking.

The most relevant statistic in all this is that about 50% of all family businesses 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 business, and especially if you are now facing ‘more’ challenging trading conditions. The question we now need to have answered is…

Why do family businesses fail and what can I do to avoid failure?

The ‘causes’ of decline and failure that are the focus of this article are particular to the Western Australian environment and are the causes you should pause to consider right now.

Generic causes of decline and failure for family businesses

  • Big projects gone wrong – You should always carefully consider who you are doing work for (esp. if you are in the mining industry), 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 – New business pipelines can 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 lower and lower prices for customers, to the point where some work completed is no longer profitable, it 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 – Your marketing and sales strategy must flow from your over-arching corporate and business strategy. With over 74% of family businesses 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 to secure a greater share of customer spend in a diminishing market. The question in this regard is of course – how? Many would argue that it’s extremely difficult to determine what marketing dollar spent resulted in success. There can 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 marketplace to actively compete for additional and new customer business, particularly in the current environment where the amount of business is far less than what it was a few years ago. As a starting point, commence this process with a ‘relationship marketing’ initiative. This in simple terms is a marketing strategy focused 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 – A book you should read on this 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 cost 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’re going to have difficulty in identifying excess costs within your business’ cost structures, are not going to be able to make the hard decisions, you should take action now and seek out someone independent who can help you through this process, to 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 – So often businesses are running blind with no budgets, profit and loss statements, 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 the leadership level. 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 knowing and understanding key data;
  • A lack of leadership – 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, seldom are there business individuals 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 the nature of staff member and the nature of work will in-turn again demand a very different type of leadership style. An assessment of business culture and team dynamics in the context of the environment and circumstances the business finds itself in is required, then reconciling this to the leadership style in evidence. You need 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. One must have an ability to see reality for what it is and deal with it quickly and decisively. You only have a few levers you can pull on 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 identify the correct lever to pull and know 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;
  • 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 not to come fast enough. In times like these, business owners should put in place a 4 to 8 weeks rolling cash flow forecast, or longer if that level of visibility is possible. In addition, monitor you expected cash receipts and commitments and reconcile this back to the profile and loss.

Let’s now consider family business specific causes of decline and failure.

Before I launch into some of the family business specific causes of decline and failure, I would like to hose down the impression that all family businesses are doomed to failure. On the contrary, it is reported that about 120 of Australia’s largest 500 privately owned business are family businesses. Furthermore, some of Australia’s leading family businesses are amongst the icons of Australian business, and far more prominent and successful than those of their listed company counterparts. If one looks internationally, you will see that some of the largest and most successful companies in the world are family businesses. One can’t deny the fact that family businesses are a completely unique class of business entity, which in so many ways are far superior to their listed counterparts. A most notable fact is that family business owners and managers have a tremendous sense of purpose, and when the chips are down, exhibit an almost super-human level of resilience and determination.

Family businesses specific causes of decline and failure

  • Death of the business founder – The death of the business founder/owner is reportedly the catalyst for 78% of family business failures. Business founder who live to retirement age, becomes increasingly reluctant to face their own mortality and enter into a structured process of handing over the reigns, leaving the family in a crisis at death;
  • Failed family relationships and conflict ­– There can be no separating the family business from the affairs of the family, with this situation becoming more complex over time. Family business owners and leaders occupy the unenviable position of being ‘mega-structure leaders’, which encompasses the family business, family and the leader or manager. These three separate but intertwined systems come together to form a cocktail of very complex dynamics. What often manifests 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;
  • The intermingling of finances – Reportedly two-thirds of family business intermingle family and business 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 measure and monitor the financial performance of the business accurately, and secondly, this in fact can be catastrophic for the family and the business. Always consider your business entity ownership structure, and make sure to structure this in a manner that takes into account potential risks and how to best mitigate them. Quite obviously, family businesses and family finances should be separated to the fullest extent possible and furthermore, family assets should be removed from the business risk to the maximum extent possible. This is a complex subject best engaged as early in the process as possible, as over time it becomes increasingly challenging and costly to implement. In this environment, and particularly if your business is experiencing difficulty in this environment, you need to pause and consider your family business/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 family businesses have access to limited financial resources and lines of credit. The vast majority of family businesses are self-funded, and in many cases continue to do so out of family assets and the family home mortgage. In a declining business environment, a significant strain may be put on these limited financial resources, and it is important to bear in mind that banks will go only so far and no further. It is therefore essential to understand the limitations to these scarce resources and to clearly identify at what point in the future that limit might be arrived at. So many family businesses tend to leave this until it’s far too late and there’s 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. For those family business owners and managers that are slow to take action and embrace necessary change what tends to jolt them into action is when they can clearly see what is at stake (often through a business advisor and strategist), things like that family home, investment properties etc., should the business fail. Business owners need to see beyond personal financing and bank debt when considering funding options for their businesses, and furthermore should explore shareholder equity as a potential funding option, casting beyond ordinary voting shares as the only instrument at their disposal. This is a very involved topic which must be dealt with by a very suitably qualified and licenced advisor;
  • A reticence to call in outside help – A few years ago, 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. This ‘alpha-male’ syndrome is one of the reasons that even when the chips are down some male owned family businesses cannot bring themselves to call in outside help, and even if it is indeed sought out, the advice is sometimes not taken. A business in crisis or decline can be a very stressful situation to deal with and even more so when facing it alone. It’s always a good idea to engage an expert and independent advisor that can help with impartial advice and provide helping hand when implementing robust strategies and process to build a better and stronger business.
Article by
Doug Verley
Doug’s 32 years of work experience spans the banking, investment management, life insurance, mutual fund, accounting, property, mining services, construction, fabrication, engineering, printing, training, fire prevention and numerous other industries, with over 25 of those years entrenched in all areas of strategy development, planning and implementation, some of these as Group Strategist of a listed life insurance Group.

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