During a recent visit to Southeast Asia, I recalled the importance of family owned businesses in the region. On my trip, I observed a trend toward greater involvement from the second generation of family members in running such businesses. As investors, we believe management transitions are important to monitor as they can sometimes lead to changes in strategy, operations, organizational structures and controlling ownership. Family owners generally have a keen interest in ensuring that the transition to the next generation goes smoothly. “The (so-called) Chinese family curse is to be avoided,” one family member told me, referring to an expression that states that wealth does not pass three generations.
Obtaining the proper structures for governance and control to ensure sustainability of an institution is important. In the Philippines for example, families tend to have written constitutions governing all aspects of a family’s involvement in the business. One conglomerate’s family constitution requires compulsory meetings amongst family members every Tuesday for lunch where all strategic matters are discussed and approved by a majority. Once a decision has been reached, the constitution forbids any public dissension. Another industrial company’s family constitution has elaborate guidelines for incorporating new members into the business. To work for the family business, prospective employees must be college graduates and begin work as an entry-level management trainee for two years. They are also not allowed to participate in outside ventures.
Transitions can often lead to changes in control. To maintain control within the family, one Filipino company created a trust intended to hold the family’s shares for perpetuity. Subsequent generations therefore will have to depend on dividends for income. Succession planning within the family has also become more systematic. Historically, the eldest son succeeded the founder. I noticed that quite a few companies in Singapore and Malaysia have abandoned this tradition. Instead, oftentimes, the mantle of leadership is passed to the most capable son or daughter, or in some instances, an outside manager.
Investing in family owned businesses can be an attractive proposition for minority investors. Owner managers minimize the principal agency problem as they tend to have “skin in the game” and decades-long time horizons. However, appropriate structures need to be in place to protect minority investors from malevolent or incompetent controlling shareholders. As one CEO once said to me, “I can make long-term investments at the expense of short-term profitability, which a professional CEO won’t do. I am the founder’s son and no one can fire me if it doesn’t work out.”
Tarik Jaleel, CFA