Family businesses usually formed from entrepreneurial action of family member



Family owned or controlled businesses are usually not seen as one of the main forms of ownership present in the business world. From the little mom-and-pop stores located near your home to huge global conglomerates such as Samsung, BMW, Wal-Mart and many others. Around a third of the companies listed in the S&P 500 index and 40 percent of the 250 largest companies in France and Germany can be considered to be family-owned companies [1] once the original owners and family members have a fairly significant share and have some sort of influence on important decisions.

Family businesses are usually formed from an entrepreneurial action of a family member that have all control and ownership of the company. As the business progresses and expands from its original entrepreneurial startup it can face several structural and performance challenges that should be addressed in order to continue expanding. For example, the next generation of managers coming from family members may not be exactly suitable for the position and it becomes clear for the staff that the only reason why these managers are in charge is their family connection.

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Besides, through time the number of family members tends to increase faster than the actual diversification of the business and some members are connected to the company just through the ownership of shares this relationship might bring problems to the company's future if formal actions are not taken in order to prevent family ruptures to damage the healthy business. According to Caspar, Dias & Elstrodt (2010) less than 30 percent of family businesses are able to sustain a healthy operation after the third generation of family ownership.

Literature Review

It seems that there are no great economic differences between the strategies and structures of family and nonfamily business [2] because firms competing in the same market should dispose the same resources in order to succeed. However, (Chua, Chrisman, & Bergiel, 2009) point out that there are some differences regarding the strategies, structures, governance and processes between these two types of firms, and the way they manage these differences is very important to guarantee the firm's future success or failure.

A family owned company that is willing to upgrade and reach a higher market value needs to face some threshold decisions to be able to compete in the global market. The firm's main decisions are whether to professionalize and/or formalize its processes in order to achieve the necessary competitiveness or to remain in the same basis. It is important to point the differences between formalization and professionalization to be able to clearly identify the next step that should be taken. Dekker (2010) defines formalization process as a movement from informal controls to a more formal setting with strategic planning, without necessarily the introduction of new features but rather a changing process on how things are done internally.

Professionalization, on the other hand, according to the author is a process of mainly bringing external managers, establishing governance policies and structures such as boards and specially delegating control to other managers in order to decentralize the decision-making inside the firm. The main difficulty in the professionalization process is the transition to external management, leading to a new functional structure of family members inside the company [3] that can be seen as a threat for family members' power within the organization.

According to (Hofer & Charan, 1984) the most difficult step in the development of a competitive business is the transition between an entrepreneurially managed to a professionally managed firm. This transition from the entrepreneurially to professionally managed company is not only related to the management practices but also related to the firm's cultural values that need to move along the new management process.

There are many cases of SMEs and family owned business becoming more competitive in the market by means of product and process upgrading while just a few are able to develop a real functional transformation towards being professionally managed [4] . This process is usually more difficult due to the fact that professionalizing a firm consists in moving this firm from a centralized decision-making structure, highly dependent on one or two individuals, to a broader decision-making process in a new functional structure, where the power is spread and tasks are delegated according to personal capacity. Another important change that occurs in this transition is the fact that the usually very friendly and paternalistic atmosphere that comes along with entrepreneurial management becomes a more formal and analytical environment.

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For being such an important yet complicated changing process the authors says that after the startup process, the transition from an entrepreneurial management style to a professionally managed company is the most likely period for business failures.

This difficulty to manage the transition from the firm's owner centralized decision-making to a professional management can be studied through the agency theory. This theory was created to analyze the relationship between managers, or agents, and owners, or principals (Bergiel & Chang, 2005). The main idea is that an agent would never be better in managing the principal's company than its owner, once the first is not closely related to the company's obligations and interests.

According to the author, three conditions must be satisfied to the development of an agency problem: both parts must have divergent interests (e.g. principal wants the long term sustainability of the firm's financial position while the agent wants the short term profits in order to receive annual bonuses), there should also be asymmetric information and the decision makers should act rationally. The results from an agency problem can an adverse selection or a moral hazard issue. The first happens when the principal has no access to all information available and needed to hire the agent and ends up hiring someone that is not as able and committed as he would desire. This brings the problem that the new management of the company would not be able to continue and develop the business as the owner would have done.

The moral hazard issue is related to the agent's behavior of using the principal resources for its personal benefit. It is the idea of showing great short-term results in order to increase the annual bonuses and therefore it would not make decisions based on the real necessities and opportunities of the firm. In order to diminish the moral hazard effects "the professionalized firm must evaluate the performance of managers and provide incentives that will motivate them to achieve the firm's goals" (Chua, Chrisman, & Bergiel, 2009).

These are some of the reasons that make a large number of family businesses to keep on having top managers in both the management and governance responsibilities [5] . For small companies this governance model may fit the strategies as it is less costly than the alternative of having a separate board of advisors or directors.

However, having a separated board is essential for the company to focus its attention on identity and discipline issues that usually cannot be done when the top managers are part of the family (Davis, 2007). Besides, according to the authors, having a good board is crucial to bring challenging and new ideas to confront the managers, resulting in better decisions and improved management quality. Managers, and especially family members would still be the ones having more power but they would be challenged by the board to pursue the best for the company in terms of quality and results.

Based on what has been seen previously, to professionalize a family business it is necessary to bring external influence and management in order to develop a new formal structure. Therefore it is important to understand the requirements to hire a good manager. Hall & Nordqvist (2008) paper states that there are two main aspects that should be taken into account when hiring an external manager. First there should be analyzed the formal competencies of the manager, such as its educational level, core competencies and quality attributes.

Secondly, and this is especially the case of family business, there should be taken into consideration what the authors call the cultural competence.

"Cultural competence refers to an understanding of the unique sociocultural patterns originating from the family's influence on a business" (Hall & Nordqvist, 2008).

Thus, as family businesses usually have a particular environment that refers back to its owners' core values, it is important to take this specificity into account when hiring a new external manager. This manager shall fit into this organization's culture instead of trying to change it.

Key Question

As shown previously it is not an easy task to professionalize a family owned firm, especially because of the spread of the decision-making process from one entrepreneurial manager to professional managers. This paper aims to understand and analyze how a family owned or controlled firm can professionalize its operations without bringing any downturns to the company's core competencies and cultural values.

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This question is important not only academically to understand the variables present in the transition process from entrepreneurial to professional business, but also for practical analysis by company owners on how to manage this transition process without harming its company's business or even on how to personally manage the loss of full control over I own business in order to let it develop faster in the global market.


To address the question proposed I will have an intense literature review related to family owned companies in order to fully understand its functioning, and how they can manage to make this necessary transition. In parallel