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Six Reasons Why Family Businesses Fail – Part 2 of 2

By April 25, 2016July 12th, 2023Uncategorized3 min read

Whoever first said “it takes money to make money” said a mouthful. When a business tries to operate without adequate capital, it’s like a bird trying to fly without wings. If a family firm lacks access to capital, it spurs a host of problems that, together, can readily bring down the firm. That’s why inadequate capital is the fourth in this continuing list of major reasons why family businesses fail.

Inadequate Capital

Inadequate capital leads to increased borrowing costs, skimping on maintenance and repairs, insufficient investment in product development, inability to take advantage of cash discounts from suppliers, lack of capacity to exploit opportunities and on and on. If that’s not enough to concern family business leaders and owners, consider that another casualty could be dividends paid to shareholders.

A business limping by on inadequate capital will find it difficult to expand and even to maintain existing market share and reputation. Ultimately, insufficient capital can lead to an insolvency crisis and forced sale or bankruptcy.

Weak Financial Controls and Reporting

Unfortunately, capital shortfalls may not be recognized until too late due to weak financial controls and reporting. This is the fifth of our six major reasons for family business failure. The oft-cited maxim “what gets measured gets managed” is apt here as is its reverse: “what doesn’t get measured doesn’t get managed.”

If business leaders aren’t getting timely reports, they may be caught unaware by a capital shortfall. If they haven’t instituted effective financial controls, they may be unable to keep shortages from recurring. This can lead to a death spiral of greater borrowing costs, failure to reinvest, shriveling margin and ultimate failure.

The Family Effect

The family effect is the last but not least reason why family business fail. It doesn’t sound like a problem. Working with family members seems like a desirable objective. And, indeed, one of the joys of family business can be the opportunity to spend time working alongside the people one is closest to. When business leaders know and understand each other as well as family members are likely to, it can increase the profitability of a family firm while also making it more pleasurable.

However, the family effect has a flip side. The term is actually shorthand for multiple potentially problematic traits of family firms. One trait is the tendency to have family member as leaders, even if they are not really up to the task. A second is reluctance to replace non-performing family employees. A third is the way family leaders sometimes lack the objectivity of non-family executives, making decisions based on emotional ties or personal considerations. These may not sound like serious flaws, but taken together they can be as toxic to a family firm as the other major failure causes.

These six causes are potential problems. They’re not inevitable. Studies show that the typical family firm has a relatively short existence not extending past the first generation. That suggests that being alert to common causes of failure is a basic requirement for family business leaders. However, the world’s oldest and many of the world’s largest businesses are family businesses. And that clearly shows that, while dangers to family business success abound, they can be effectively managed and many family businesses can avoid failure and positively thrive.