“All Models are wrong, but some are useful.”-George Box
Today, I want to reflect on the concept of models and how they relate to family business. Models, not of the aesthetic variety, are a tool we use to explain how reality works. Often times, in fact, the model is what gives us the first accurate way of describing something. The best models manage to be both intuitively simple to grasp, as well as highly comprehensive – i.e. they cover a lot of ground.
Family businesses have existed for as long as time itself – even at the dawn of human civilization, a father and son working the same plot in an agrarian society is a proto-family business. The reality is that many businesses even today function as parent / child apprenticeship models in which the parents are able to ensure the future livelihood of their progeny by passing along a vocation that provides value in the economic system.
The unique challenge of the family business is that it is unique synthesis of two worlds that we do not readily join in our modern psyche – the joining of family and business. If we consider the modern construction of business dating back to the first joint stock corporation of the Dutch East India Company of 1602, modern business and business practices arose because the individual / family unit alone was unable to bear the risk / complexity of many modern corporate undertakings. Corporations generally encapsulate a much larger undertaking than vocational transfer. As such, when the world of family and business become fused, it is not surprising that challenges result.
Families have their own struggles, and an accompanying set of language and tools for addressing. The same for businesses. Even beyond that are the second-order affects that occur as each component affects the other, and the other side responds – i.e. how is the family shaped by the goings on of the business and vice-versa.
To help think through these challenges, a number of different models have been proposed as a way for clarifying different questions and roles. We consider the most significant ones below.
Model 1 – Family & Business
Arguably, this is the simplest, common-sense model for thinking about a family business for a long period of time. It recognized that there were two primary spheres of consideration – the family and the business.
Figure 1 – Two Circles
Source: Family Capital Strategy, LLC
While this model is intuitively simple, those who work with family business began to observe other challenges that did not fit within this construct.
Model 2 – Three Circles Model
In the 1970s, John Davis and Renato Tagiuri at Harvard Business School articulated the first model of family business that began to bring additional depth – what is today called the 3 circles model.
Figure 2 – The Three-Circle Model
Source: Tagiuri and Davis, 1982
The three circles include the business, the family and ownership. The overlapping Venn diagram does an excellent job of explaining all the various roles that people may have in the family business system.
The wonderful thing about the three circles model is that by adding one additional component it opens up a world of additional conversation and explanatory factors that those who interact with FB’s found immediately relevant. It was easy to find your place in the three circles, or to frame a problem as a three circles problem. Most important in the three circles are the areas of overlap – which rightfully showcase potential areas of conflict or confusion.
Model 3 – Four Rooms
One additional, and helpful model comes from the team at family business consulting firm Banyan Global – called the Four Rooms. Explained in an HBR article entitled, “Making Better Decisions in Your Family Business,” this model recognizes that there are Owners, Boards, Management and Family and each of those have considerations, responsibilities and decisions to make that are related to, but also different from one another in a family business system.
Each component has a ‘room’ where decisions pertinent to it are made. So there are: the owner room, the board room, the management room and the family room.
Figure 3 – The Four Rooms
Source: Banyan Global
While the three circles highlights the various constituencies of a family business system the Four Rooms recognizes that as families engage with one another and actually “do the work”, role confusion is a common occurrence. By recognizing these differences and placing discussions in the proper location, the system can make sure that the right decision is made in the right room. This helps ensure that the right people are making the decision, as well as the right voices are being heard in that process.
As well, the room concept also recognizes the different types of decision making models that are deployed for different types of decisions. Ownership decisions are based on ‘vote’ considerations, while family decisions are likely to be made more under a consensus driven model.
Model 4 – The Five Capitals
The final important model for family businesses was introduced by Jay Hughes in his 2000 book, Family Wealth Keeping it in the Family – known as the Five Capitals. Hughes, a long-time advisor to families and an estate attorney, identified that there is an additional dimension to consider regarding the family system.
He highlighted that the resources that family businesses brings to bear in the on-going development and furtherance of their family system are a factor worthy of their own consideration. While financial capital and resources are easily identifiable and accounted form – Hughes expanded the dialogue to consider the other factors supporting the family system which he termed – Human, Intellectual, Social, Spiritual capitals.
By considering each capital in their entirety, you can fully comprehend all the resources that the family has and brings to bear. As well, it helps to counter-balance the out-sized influence that financial matters may have in the day-in and out affairs of the family enterprise. It opens the tent further for all family members to find a place to contribute to the family system outside of the management of the family’s business affairs.
Systems of any sort can be confusing. When various component parts combine, these interactions produce effects that often are rational, comprehensible and predictable. Yet, often there are unpredictable elements that arise that impair the smooth functioning of the system overall. As George Box noted, “all models are wrong, but some are useful.” The same is true for the models used to describe family business systems. Because of all the constituentsin a family business, there are often times so many dimensions at play in any matter that dissecting what is actually occurring is incredibly challenging. Instead, models like the three circles, four rooms and five capitals arm us with a set of lens by which one can interpret the circumstances presented.
About the Author
David Wells is the Founder and CEO of Family Capital Strategy, a strategy consultancy based in Nashville, TN. We help families stay invested together by collaborating with them to build world-class family offices. We provide objective, conflict free advice in a strategic, customized and multi-generational manner.