Numerous academic studies have reached one common conclusion regarding the performance of family businesses – they outperform their public peers. General accepted wisdom as to why points to the family’s ability to take a long-term view when making decisions vs. public peers held to a quarterly reporting cycle. This make sense. In business where decisions are always made with a degree of uncertainty, the flexibility to pursue a course of action that may require take time to come to fruition is incredibly powerful. Today we want to consider how this advantage applies to family investment activities.
As owners of the family business, the family may wear many different hats as they approach their financial assets. They may serve as operators where they have taken a hands-on approach towards the management of the business. They may also serve as investors, where they provide capital to others in exchange for a rate of return.
We would argue that the same time horizon advantage families have as operators, is also in place for family investment activities. Investing has three generally recognized sources of advantage – informational, analytical, and behavioral. In the hyper-competitive markets of today, with 10,000+ private equity funds, 10,000+ hedge funds, and countless mutual funds all chasing ideas, informational (unique information) and analytical (unique interpretation of information) are fleetingly rare and becoming ever more so.
Behavioral advantages may be more unique and sit at the interplay of the unique characteristics of an asset class, compensation structures for investment performance, and a host of well documented behavioral biases that affect decision making. Within this complex mix sits the greatest behavioral advantage of all – time horizon. All great investment success comes from a unique insight that allows an opportunistic purchase today relative to future prospects – i.e. buy low and sell high. The multi-generational time horizon of families is particularly well suited to leverage this sort of investing.
And yet, despite this being the family’s most powerful advantage in investing, it is also its most tenuous. The reason is that the ability of the family to have a long time horizon is nearly always a function of its willingness to do so. This difference between ability and willingness is often the difference between quantitative and qualitative realities. The assets of the family may very well support a long-term horizon, but if the family falls apart in the interim, it is to no avail.
As such, how a family business oversees and governs its investment decision making is of critical importance to their long-term success. When this governance framework is not firmly in place, the family is facing a significant risk of losing its advantage. Over the coming weeks and months, we will explore in much greater detail the characteristics of high functioning governance, and how families can create the structures necessary for success.