Identifying Value in Family-Owned Businesses - McKinsey

19/03/2024 14:46 Identifying value in family-owned businesses | McKinsey
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Private Equity & Principal Investors
Identifying value in family-owned
businesses
March 14, 2024 | Podcast
Outperforming family-owned businesses use a

combination of value-creating mindsets and actions.
Private equity firms looking to engage should
understand them.
F
amily-owned businesses (FOBs) are a large part of the global
economy and a source of investment for private equity (PE)
firms around the world. In this episode of Deal Volume, McKinsey’s
podcast on private markets, host and McKinsey Partner Brian Vickery
speaks to Senior Partner Acha Leke and Consultant Igor Carvalho,
who recently published their research on FOBs in an article titled
“The secrets of outperforming family-owned businesses: How they
create value—and how you can become one.” Leke and Carvalho are
members of McKinsey’s Family-Owned Business Special Initiative,
which seeks to create lasting value and impact for family businesses
around the world.
Together, Vickery, Leke, and Carvalho discuss the attributes that

outperforming FOBs possess, the opportunities PE firms could have
to invest in these companies, and how investors can balance their
https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/identifying-value-in-family-owned-businesses#/ 1/10
aspirations with a family’s long-term vision. An edited version of their

conversation follows.
How FOBs rise to the top
Brian Vickery: Something we’ve noticed in our annual private

markets report over the past few years is the growing influence of
privately held businesses.[ 1 ] Companies have been staying private
longer and growing bigger, often through several funding cycles.
While VC [venture capital] and growth equity fundraising are down
substantially, the longer-term arc seems to be that an increasing
number of larger, private companies are backed by sponsors. Today’s
conversation intersects with that trend. Many FOBs become great
candidates for sponsors at some point in their evolution. Acha, what
trends did you find when researching FOBs?
Acha Leke: About a year ago, McKinsey relaunched its Family-

Owned Business Special Initiative. As part of that work, we wanted to
understand what it takes to outperform as a family business. We
studied a large data set of family businesses, looking at 600 publicly
listed family businesses and comparing their financial data and
performance with that of 600 publicly listed nonfamily businesses.
We then surveyed another 600 primarily private family businesses
and interviewed about 30.
We found that family businesses outperformed nonfamily businesses

—which has been well-known and documented—but we got to
understand the underlying reasons for that outperformance. In terms
of TSR, family businesses outperformed by about 14 percent because
of their operational performance. That shows how resilient family
businesses are, what their long-term perspectives are, and how
operations affect their financial performance.
We also found that, while family businesses outperformed nonfamily

businesses across every quintile, the best family businesses
outperformed the best nonfamily businesses by three times in terms
of the average delta of economic spread. We identified 120
companies from our sample that were in the top quintile. Igor, could
you share some of the findings from the analysis?
Igor Carvalho: We confirmed that FOBs outperform non-FOBs in

terms of TSR, but we wanted to understand the actions under the
control of management that allowed FOBs to outperform. When we
looked at economic profit—which includes accounting profit and
opportunity cost—we saw that FOBs outperformed non-FOBs by 17
percent on average in the past five years. When we look at the
economic spread—which is ROIC minus the weighted average cost of
capital—the outperformance was even more significant, at about 33
percent over the past five years.
We not only saw nuances for growth, but we also got some insight
into the inherent challenges that FOBs face. For example, FOBs tend
to underinvest in research and development, which limits innovation
and entrepreneurial risk-taking. They’re a little bit more cautious, and
they grow slower than non-FOBs during postcrisis periods. Many also
face governance challenges due to family ownership.
We synthesized our learnings on the 120 companies that make up the

top quintile to develop a value creation formula: our “4+5 formula.”
The 4+5 formula, broadly speaking, is based on four critical mindsets
and five strategic actions. The four critical mindsets are traits or
characteristics that were common to all FOBs but were expressed
more clearly by some of the top-performing FOBs. The first one is a
clear purpose that extends beyond the bottom line. The second is a
clear long-term perspective or orientation with a willingness to invest
in the future. The third is a cautious approach to finances; FOBs have
a conservative approach to how they structure their growth that
affords independence and resilience. And the fourth is an efficient

decision-making process that is centralized and streamlined.
The five strategic actions are actions or best practices that set
outperforming FOBs apart. First, they have diversified portfolios with
a significant share of revenues coming from beyond their core
business. Second, they allocate capital dynamically to high-growth
areas. Third, they excel at both capital efficiency and operational
excellence. Fourth, they focus relentlessly on talent—attracting,
developing, and retaining top talent. And fifth, they have very strong
governance processes, which is a key area of ventures for FOBs.
Acha Leke: To put some of these findings into context, in terms of

diversified portfolios, for instance, 40 percent of outperformers had
more than half of their revenues coming from noncore businesses.
Non-outperformers have only 7 percent of their revenues coming
from noncore businesses. In terms of capital allocation, about 60
percent of the outperformers had reallocated 30 percent of their
capital to other regions or industries within the past five years. Only
20 percent of non-outperformers had dynamic capital allocation.
Last, in terms of capital efficiency versus operational excellence, our
research showed that young companies are better investors but
become better operators as they grow. The best can do both at the
same time: they maintain that investment edge as they become
better operators.
Brian Vickery: In many ways, it seems as though the 4+5 formula

contains best practices for any company. Do best-performing FOBs
do it better?
Acha Leke: We found that the four critical mindsets are more relevant
for family businesses. The five strategic actions can be applicable to
any business, but many don’t do them. The family businesses that
applied the four mindsets with the five actions were able to move up
at least one or two quintiles over a five- to ten-year period. So there’s

huge value-creation potential by applying this formula.
FOBs as investors and operators
Brian Vickery: One point that stood out to me from your article was
that FOBs tend to have a higher ROIC than non-FOBs of a similar
size, which is important to PE investors. Why are some of these family
businesses better investors?
Igor Carvalho: When we broke down ROIC to its core components,

we looked at operating margins, or EBIT margins as share revenues.
And then we looked at capital turnover, or revenues over shareholder
equity. We found was that FOBs in our sample outperformed non-
FOBs both in operating margin, indicating that they’re better
operators, and in capital turnover, indicating that they’re better
investors. There was some nuance when we broke down our data set
into companies of slightly different characteristics.
For instance, when we looked at company size, we found that midsize

FOBs—which are the companies in our data set that have revenues
of between $150 million and $5 billion—tended to be more efficient
investors. They generate almost 9 percent higher capital turnover
ratios of 1.14 versus 1.05 for midsize non-FOBs in our sample. This is
largely driven by better PP&E [property, plant, and equipment]
revenue ratios, which were almost six percentage points better than
non-FOBs. This suggests that FOBs use capital more efficiently to
extract more revenue per dollar invested. When we looked at large
FOBs—companies in our sample with revenues of between $5 billion
and $100 billion—we found that they tended to be more efficient
operators, generating EBIT margins that are 1.5 percentage points
higher than those of non-FOBs. This was mostly driven by lower cost
structures, specifically by lower COGS [costs of goods sold]-to-
revenue ratios, even when some of the other cost elements, like
SG&A [selling, general, and administrative expenses], were relatively

similar to non-FOBs.
In terms of investment causes, we found that FOBs made decisions

efficiently and effectively. They can make decisions without passing
them up a chain of command or dealing with uncooperative boards,
which reduces friction and allows these companies to identify bets
that they see as value generating and move assets quickly to those
areas. This element of capital allocation is tremendously important. A
consistent pain point of capital allocation has to do with tyranny of
inertia, which is the tendency companies have to keep sending the
same amount of capital every year to the same areas of the company.
FOBs in our conversations were good at avoiding that tyranny of
inertia.
On the operations side, the proximity that founders have to the

business helps them gain a better perspective of what’s going on and
where the areas of opportunity are. For example, we talked to the
leaders of a multigenerational South Korean conglomerate. The
chairman of the company visits the production lines every week and
knows employees by name, which helps break down silos and shows
him where areas of opportunity for efficiency might be. A lot of
companies are trying to make managers think like owners, but if you
position owners to manage, you avoid that issue altogether.
FOBs are also very ingrained in the places where they operate: they
have a deep understanding of their countries and industries, so they
can influence regulation and domestic policy. This privilege comes
from years of building personal relationships with stakeholders
across the value chain. Last, the fact that these companies have a
family identity can be an advantage in certain markets. A family’s
reputation is a powerful driving force for getting things done and a
sign of accountability.
Acha Leke: Taking a step back, the younger family businesses are
better investors: they’re better at identifying opportunities and going
after them. If the product–market fit is not suitable, they can pivot
quicker because they’re more agile and nimble. As they grow and
they mature, they become better operators because they have a
deeper understanding of their relationships with customers and
suppliers. In some cases, they have multiple generations of families
running the business who have that knowledge.
Investment opportunities in FOBs
Brian Vickery: Acha, what have you learned through your work with
PE firms in Africa? How can PE investors find opportunities in FOBs,
and what should they watch out for?
Acha Leke: Family businesses contribute to more than 70 percent of

global GDP and 60 percent of global employment.[ 2 ] So they’re
relevant in emerging markets and in many developed markets. PE
firms must learn to understand the mindsets of family businesses and
the implications they have for a PE partnership, then decide whether
the company is an opportunity for investment.
One tension I’ve noticed is the lack of long-term perspective among

PE investors. Some family businesses think ahead to multiple
generations, whereas some of the PE investors think about exiting in
five to seven years. Another area of tension is the cautious financial
stance of family businesses. Their leverage ratios are lower in
general, which doesn’t mean they don’t take on debt. A PE firm may
want to lever up, but the FOB could be resistant.
But there are also several areas of opportunity. If you look at the
early-stage businesses, they grow revenue twice as fast as nonfamily
businesses. As they mature, the growth tends to mirror that of
nonfamily businesses. Why is that? In some cases, there’s a loss of
the founder’s entrepreneurial edge, and the next generation is not as

hungry. PE firms can help them understand where the growth
opportunities are and go after them. Second, in some cases, FOBs
are too cautious about their finances. In downturns, they tend to do
better than nonfamily businesses because they’re quite cautious, so
we see a lot fewer FOBs that go bust. But that also means they don’t
quickly come out of recovery periods. So a PE firm can help them
think about how to accelerate the growth coming out of the recovery
period.
Third, in some cases, too many family members may be involved, so

they struggle to professionalize the business. I’ve seen many of the
PE firms, at least in Africa, help in that area. They help professionalize
both the boards and the business, bringing in external management.
The outperforming companies have a lot more nonfamily members
involved in the decision-making process. Fourth, PE firms can help
with governance, putting in place the right governance mechanisms
to effectively run the business. And last, investors can help a FOB
drive their performance management more proactively to increase
operational excellence.
Brian Vickery: If I’m a PE firm looking at FOBs, I could take the 4+5
formula and use it in two different ways. I could evaluate a business,
determine whether it has all the hallmarks of a business that’s likely
to outperform, and decide whether this is a business that I want to
own. Or I could use the formula to look for companies that don’t do
that well across all these dimensions and pick opportunities where I
think I can make a real difference.
Acha Leke: They could also use the formula to determine if they want
to stay away from a business. If they have a number of these
challenges, they may struggle to benefit from the investment. The
4+5 formula can help investors identify businesses where they could
help add value, or they can use it to identify the main attributes that
create that value.
Balancing investor aspirations with
FOB attributes
Brian Vickery: There are several attributes you have identified that
help FOBs outperform but aren’t things PE firms often do. If there is
a set of characteristics that we see in firms that outperform and PE
firms want to come in and change some of those characteristics to
get the financial outcome that they’re interested in seeing, how do
you see firms wrestling through that conflict?
Igor Carvalho: There’s a bit of nuance. The data we have on dividend

yields, for example, helps to dispel this notion that FOBs are used
merely as a means to extract value rather than reinvesting. Dividend
yields for the family aren’t too low necessarily. These companies exist
with sophisticated participants in efficient markets. There has to be a
balance of the dividends, whether to sustain the family lifestyle or to
fund, finance, or deliver the required returns for a PE firm; dividends
can be balanced against the needs of the business for growth and
reinvestment.
Similarly, in terms of leverage, low debt ratios are one of the elements
that afford resilience and help sustain longevity in FOBs. But too little
leverage is problematic to the extent that it limits the company’s
ability to bounce back from moments of crisis or limits investment in
the future. So those are areas in which PE firms can play a significant
role.
Last, when we think about talent and longevity of talent, we find that
elements of talent development that build trust and loyalty in a
company have positive downstream effects when you take a long-
term perspective. Talent isn’t just about the tenure of the talent—it’s
about the quality of the talent. The outperforming FOBs that focus on
talent don’t just retain talent for the sake of retaining talent. They
really focus on attracting and developing the best talent. They focus
on making it attractive for the best talent to stay within the company.
Those are things that a PE firm might want to consider when
investing.
Acha Leke: As part of a firm’s due diligence, they should understand

what degrees of freedom they have and what actions the company
may not be excited about. As a PE firm, it’s important to understand
the family—to understand not just the business but also the people
behind the business—and then they can understand which actions
would make the family most comfortable. It’s important to have those
conversations up front before a firm makes the deal to avoid
tensions.
1. “Private markets: A slower era,” McKinsey, February 20, 2024.

2. “Empowering family business to fast-track sustainable development,” UN Conference
on Trade and Development, April 13, 2021.
ABOUT THE AUTHOR(S)
Igor Carvalho is the global practice manager for the Family-Owned

Business Special Initiative and a consultant in McKinsey’s Mexico City
office. Acha Leke is chairman of McKinsey’s Africa region, a member
of the McKinsey Global Institute and McKinsey’s Shareholders Council,
leader of the Private Equity & Principal Investors Practice in Africa and
McKinsey’s Family-Owned Business Special Initiative, and a senior
partner in the Johannesburg office. Brian Vickery is a partner in the
Boston office.
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19/03/2024 14:46 Identifying value in family-owned businesses | McKinsey

Identifying value in family-owned

Outperforming family-owned businesses use a

Together, Vickery, Leke, and Carvalho discuss the attributes that

aspirations with a family’s long-term vision. An edited version of their

How FOBs rise to the top

Brian Vickery: Something we’ve noticed in our annual private

Acha Leke: About a year ago, McKinsey relaunched its Family-

We found that family businesses outperformed nonfamily businesses

We also found that, while family businesses outperformed nonfamily

Igor Carvalho: We confirmed that FOBs outperform non-FOBs in

We synthesized our learnings on the 120 companies that make up the

affords independence and resilience. And the fourth is an efficient

Acha Leke: To put some of these findings into context, in terms of

Brian Vickery: In many ways, it seems as though the 4+5 formula

at least one or two quintiles over a five- to ten-year period. So there’s

FOBs as investors and operators

Igor Carvalho: When we broke down ROIC to its core components,

For instance, when we looked at company size, we found that midsize

SG&A [selling, general, and administrative expenses], were relatively

In terms of investment causes, we found that FOBs made decisions

On the operations side, the proximity that founders have to the

Investment opportunities in FOBs

Acha Leke: Family businesses contribute to more than 70 percent of

One tension I’ve noticed is the lack of long-term perspective among

the founder’s entrepreneurial edge, and the next generation is not as

Third, in some cases, too many family members may be involved, so

Balancing investor aspirations with

Igor Carvalho: There’s a bit of nuance. The data we have on dividend

Acha Leke: As part of a firm’s due diligence, they should understand

1. “Private markets: A slower era,” McKinsey, February 20, 2024.

ABOUT THE AUTHOR(S)

Igor Carvalho is the global practice manager for the Family-Owned

EXPLORE A CAREER WITH US

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