The backbone of the economies of Latin America, and of most emerging markets, has traditionally been family-owned businesses, whether they be huge conglomerates or corner bodegas. In more developed economies, stock markets tend to view family-owned businesses¹ with suspicion: when family members aren’t squabbling, it is thought, they are looking after their own interests rather than those of the business. Empirical evidence suggests that there is some truth to the common observation that the first generation builds the company, the second preserves it, and the third squanders it. In fact, fewer than 15 percent of family-owned businesses survive under family control beyond the third generation.

But family-owned businesses have their purposes, especially in areas that lack developed capital markets and a cadre of professional managers: if successful, they provide investors in emerging markets with an alternative to holding illiquid or volatile shares in opaque public companies. Last year, the market capitalization of Latin America’s stock exchanges represented only 32 percent of gross domestic product, while the corresponding figure in Southeast Asia was 114 percent of GDP; in Europe, 115 percent; and in the United States, 164 percent (Exhibit 1).

Nevertheless, the representation of family-owned businesses in the ranks of the top 100 companies has fallen sharply—from 70.8 percent (1994) to 57.1 percent (1999) in Mexico and from 24 percent to 18.8 percent in Argentina—as deregulation and the advent of multinational corporations have spurred the cross-border integration of economies and industries. And many family-owned businesses cannot match the multinationals’ scale, strategic focus, cutting-edge management techniques, and deep pockets (Exhibit 2).

To survive and thrive, big family-owned businesses in Latin America must shift to strategies that will enable them to compete more successfully. To execute any high-performance strategy, they first need stronger governance models that can prevent family squabbles from spilling over into the business, help it obtain the strongest management talent, and provide for a smooth succession of power across generations.

Diversified growth

Family-owned businesses in Latin America have traditionally held interests in a range of industries. Although this approach often strained the management and capital resources of these businesses, the fact is that protectionist trade, investment, and, sometimes, foreign-exchange restrictions often made local diversification the only way to grow.

Many family-owned Latin American business conglomerates, grupos such as the enterprises controlled by the Santo Domingo family, in Colombia (airlines, automobiles, beer, the mass media, telecommunications), thrived in these closed economies, becoming dominant forces in several industries. Many of the attributes of family-owned businesses have accounted for their relative success in the region. Their informal structure, for example, facilitates quick decision making, which is vital in a region plagued by political and economic instability. They tend to have strong shared values—often rooted in a founder’s vision—and traditions that help to promote staff loyalty. They also tend to have a deep understanding of the peculiarities of their local markets and close ties with high government officials.

But the game has changed as Latin American markets have opened up to competition from multinational companies. Some diversified local competitors have found that they are simply no match for foreign focused attackers that have strong management skills, easy access to the capital they need, and the ability to offer better products and services at a lower price. Consequently, Latin American companies risk either going out of business altogether or becoming targets for takeover.

Latin America’s banking sector illustrates the trend. During the 1990s, foreign ownership rose to 27 percent, from 8 percent, in Brazil; to 24 percent, from 10 percent, in Colombia; and to 54 percent, from nothing, in Mexico (Exhibit 3). In May 2001, Citigroup acquired Grupo Financiero Banamex-Accival (Banacci), Mexico’s second-largest bank, for $12.5 billion. Banacci, a first-generation family-owned business, was controlled by its two top executives: Alfredo Harp and Roberto Hernandez.

A new family strategy

It is clear that many family-owned businesses will not survive in this new climate. Those that do will draw on their intangible strengths—not only a knowledge of the local market and a network of contacts with key decision makers but also a strong local brand and an agile decision-making process.

Some of the survivors are likely to be very successful. Many Latin American family-owned businesses that restructured over the past few years have grown profitably at very high rates and can boast higher productivity than most Latin American units of the multinationals. For example, Brazil’s Banco Itaú, controlled by the Setubal and Villela families, has increased its market capitalization by 36 percent a year since 1996. Another success story is Votorantim (cement, metals, pulp and paper), a property of Brazil’s Ermirio de Moraes family, which has reported that the company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) have risen to 40 percent of sales, from 17 percent, in the past five years—far above the averages of its global competitors in those industries.

Successful strategies for particular family-owned businesses will of course vary. Those with sustainable competitive advantages, such as access to privileged assets or technologies that can be replicated in other markets, are well equipped to specialize in a single business area after shedding noncore activities. The Cisneros Group of Companies, in Venezuela, is one family-owned business that has successfully restructured in this way. From its humble origins, in 1929, as a small materials-transport business, it expanded to become a leading Venezuelan conglomerate with a strong local brand in beverages, food processing, and supermarkets. As Latin American governments introduced open-market policies, the Cisneros Group divested its food products company, Yukery Venezolana de Alimentos (1996), and its supermarket chain, Cada (1997), to raise capital and to free up managerial resources needed to expand regionally into mass media. AOL Time Warner and Hughes Electronics have formed strategic alliances with Cisneros to capitalize on its understanding of Latin American markets. Cisneros is now one of the region’s biggest mass-media groups.

Regardless of the strategy chosen—to restructure cautiously or to dismantle and focus—one thing is absolutely clear: before implementing a successful high-performance strategy, family-owned businesses in Latin America must reform the way they govern themselves.

A better mix

Family-owned businesses tend to have weak and informal governance structures devised primarily to comply with the law and to make it possible for the business to address the family’s concerns. As a result, such businesses can put off generational-succession decisions and cling sentimentally to the traditions and assets of the family, especially those that perpetuate its name and secure its position in the community.

There are probably as many governance formats as there are successful family-owned businesses, but all of these formats belong in either of two categories: one that we call "egalitarian" and another characterized by equity concentration. Both approaches strengthen the governance structures of family-owned businesses by defining and formalizing the family’s role in the decision-making process, by providing clear options for succession planning, and by monitoring the performance of both outsiders and family members working in the company.

Egalitarian approaches

We call solutions that allow the maximum number of family members to hold a stake in the company, regardless of whether they work there, the egalitarian approach. Egalitarian governance solutions face little family resistance, since they are consistent with the Latin American belief that, in the distribution of an inheritance, all family members should be equal despite differences in, for example, sex and talent.

Egalitarian solutions usually require the creation of a family forum consisting of all adult members or, in the case of large extended families, a select group that represents the interests of all close relatives. The forum is used for venting family disputes, building consensus on major issues, and setting family policies in such matters as employment in the family-owned business, the sale of shares in it, and dividends. In addition, the forum is responsible for transmitting family values across generations—for example, by organizing activities and events aimed at helping family members to bond. An important disadvantage of the egalitarian approach is the fact that it does very little to discourage passive family members from selling their shares—threatening the family’s control of the business—if they are dissatisfied with the dividends they receive from it.

Two egalitarian governance approaches are particularly suited to Latin America’s cultural and economic landscape.

Protection. One of these approaches seeks to protect the family-owned business from the members of the family that controls it and to protect them from each other. This approach redefines the role of the family as policy making rather than day-to-day management, which is to be handled by outside professionals.

The family forum nominates the board of directors, whose ratio of family to nonfamily members is set out in the bylaws of the business. The board should include a strong contingent of highly competent outsiders—if possible, the chief executive officers of successful multinational corporations—rather than local politicians and friends of the family, who are the usual choices. To ensure alignment with top management, the compensation of the board members should be linked to the company’s performance. Like the board of any public corporation, the board of directors appoints the CEO and decides, upon management’s recommendation, whether to distribute dividends and, if so, their size. Succession is no more of an issue for a family-owned business that adopts this approach than it is for companies that are not controlled by families. Capable family members may work at such a family-owned business, but no special career track is set aside for them. The rules governing the hiring, development, and promotion of nonfamily members apply to family members at equivalent levels.

In Latin America, this kind of governance structure has been used successfully to resolve family feuds that threatened to disrupt company operations. (Sometimes the bylaws or the constitutions of family-owned businesses go so far as to prohibit family members from becoming managers.) In addition to resolving succession feuds, this structure makes it possible for a family-owned business to compete globally when the family in charge lacks the management skills to do so.

Private equity. The belief that capable family members are better suited than outsiders to manage the business is the source of an approach that builds on the business model of private equity funds.² In this case, three to five family members are chosen, either by consensus or by a majority of the shareholders, to direct the enterprise as though they were general partners. The family forum may retain the services of a third party to provide an objective assessment of the management abilities of the leading candidates. General partners, who are responsible for generating value for all family shareholders, select the board, which compensates the general partners on the basis of their success in raising the company’s market capitalization, return on equity, and net profit or in reaching some other business objective.

The remaining family members, playing the role of limited partners, are kept informed but do not participate in the decision-making process. Although they nominally set the size of the dividend, they follow the general partners’ recommendations, appearing in the annual report. Management opportunities are extended to younger family members who may have attended top business schools and shown the potential to become general partners. These family members typically serve renewable five-year terms—subject to mandatory retirement rules. The family forum, in accordance with established guidelines that define the selection criteria and process, decides which of the limited partners should be promoted to general partner. To prevent conflicts of interest, the general partners are not allowed to invest individually in business ventures that compete with the family-owned business.

Family members may resist the idea of ceding control to a small number of relatives who might fail to enlarge the family’s capital

It is true that a majority of the family members may be reluctant to cede control to a small number of relatives who—however carefully chosen and however scarce the alternative (professional managerial talent)—might not have the ability to enlarge the family’s capital. But by concentrating operating authority in the hands of a few family members who are paid for performance, this approach achieves two goals: it prevents strictly family issues from interfering with the business, and it preserves the influence of the family’s name and reputation with political and other prominent figures—an indispensable asset in Latin American society.

Equity concentration solutions

Our second major category of approaches to the governance of family-owned companies aims to ensure the family’s power across generations, so it focuses less on control of management than on control of ownership. Although concentration of ownership makes even a single defection more dangerous, the risk can be minimized by assigning shares only to loyal and highly motivated family members who work in the business and then restricting the transfer of shares.

The family forum is usually established to resolve family issues, to promote shared values, and to explain to new generations—usually, both shareholders and nonshareholders—why the founding family members decided to be so exclusive. It also issues rules for buying out family members not selected to become or remain shareholders.

Because the handful of shareholders of such a family-owned business mostly work in and draw salaries from it, the shareholders can retain earnings they would otherwise distribute as dividends. At the outset, however, the business may lack sufficient capital to buy out or compensate family members. One possible solution is to invite outside investors to purchase stakes in subsidiaries. This approach avoids diluting family control of the parent.

Although the Latin American tradition of equal treatment of heirs conflicts with equity concentration arrangements, they can be the only way for a family in conflict to keep control of the business across generations. A number of equity concentration solutions exist: shares can be distributed to any family member working in the business, for example. We, however, believe that the entrepreneurial-renewal approach—which offers shares only to family members who assume an executive role, and only at the time they do so—is particularly effective. Assuming that these executives serve the best interests of the business, entrepreneurial renewal is a way of avoiding those all-too-common situations in which risk-averse passive shareholders who are interested mainly in securing an uninterrupted flow of dividends are inclined to block the kind of restructuring and reinvestment of profits that the state of competition in Latin America now frequently requires.

The shareholders—family members who play executive roles in the family-owned business—appoint representatives from their own ranks and a contingent of competent outsiders to the board of directors according to preestablished criteria favoring, for instance, top business school professors and experienced executives from the financial sector who have previous board experience. The board, as would be expected, names the CEO and defines the criteria for selecting family members who wish to join the management of the business.

Although the entrepreneurial approach, which favors a small number of family members at the expense of others, may be more difficult to implement in Latin American countries, it provides important benefits that can outweigh its harshness. First, by aligning ownership and management interests, it speeds decision making. Second, by requiring family members to earn the right to become shareholders and executives, it helps the business preserve or recapture the entrepreneurial spirit that usually characterized it during the first generation. Finally, by providing for the rigorous evaluation of family members who serve as executives, it makes the family-owned business better able to attract outside managers, who prefer to work in companies where all employees are promoted on the basis of merit. The entrepreneurial-renewal approach is easier to implement while control remains in the hands of the founding family member or of a small contingent of family shareholders currently active in the business.

Leading US and European family-owned businesses have successfully remained in the hands of the families that founded them over the course of four, five, and, in some cases, six generations by adopting one of the governance models described above. If family-owned businesses in the developing world follow this route, they can assure their survival and stand a good chance of prospering by exploiting their distinctive local advantages.