Risk Management (RM) is an essential part of any organisation. Family enterprise advisors need to be aware that the risk appetite of family decision-makers can make or break a family business. Although leaders in advisory or board positions are generally aware of the importance of the RM function within the organisation, the proper identification, comprehension, and understanding of risk and of how it impacts the organisation and its key stakeholders should be prerequisites in order to develop organizational strategy.
When it comes to managing risk, it is important to ask: How does your family dimension impact your appetite for risk? How do you manage risk tolerance differences among family members? What process do you have in place to communicate decisions that may involve greater risk in order to build alignment and understanding within key stakeholders?
From the perspective of families with operating companies, the strategic aspects of risk management are important. Risk management infrastructure, policies, and processes may be in place, but it is the family firm’s ability to identify and assess both current and future risks and to map these risks on to its own risk appetite—and, more importantly, on to the family business’s capacity to bear the consequences of the risks taken—that will influence its long-term survival and success. A risk matrix should be compiled by the risk manager, and then an assessment of identified risks should be assembled. This assessment should examine the relevant points for each risk and divide them into relevant categories, e.g., operational, legal, marketing, personnel, and physical assets.
Types of Risk in Family Enterprise
Too often, the word “risk” evokes the feeling of danger, uncertainty and the probability of loss without recognizing the potential upside that is inherently present with good business decisions. For our discussions, we will adopt the Chinese symbol for risk that combines two components: danger and opportunity. This definition perfectly captures both the essence of risk and the problems with focusing purely on the reduction of risk.
There are many domains in which a loss or gain (opportunity) can arise within a family business context:
- Financial risk: The potential for gain or loss on a financial level measured in terms of revenue, return on investment, return on equity, shareholder value, profitability, debt level, capital expenditures and free cash flow. Financial risk is the most commonly understood meaning of the term within a business context.
- Performance risk: The potential for increased or decreased performance of the business. Decisions include operations, production, materials and human resources. An example of performance risk is purchasing a new machine to potentially reduce production time.
- Reputational risk: The potential for gain or loss to the standing or status of the family and business including its name, brand and products or services. Decisions include ethics, safety, security, quality, innovation and sustainability.
- Relationship risk:
- Nonfamily: The potential for solidifying or weakening the rapport and trust with customers, employees, suppliers and other stakeholders. Decisions include contractual, financial, procedural, communication and safety. Reputational and relationship risk are closely associated with one another. There is greater relationship risk for family businesses, for example, when making decisions about layoffs due to the loyalty and closely held relationships many family businesses establish with their nonfamily employees.
- Family: The potential for strengthening or abating trust and cohesion within the family. Family relationship risk is similar to relationship risk except it focuses on family relationships and the family legacy. These decisions are not merely financially oriented because they can affect the livelihoods and quality of life for parents, uncles, siblings, cousins and other family members.
- Safety risk: The potential for creating harm or increasing the protection of people as well as material goods or properties. Decisions include compliance, regulatory, training, operational and procedural.
Risk Management and Ongoing Communication within the Broader Family
Managing risks in the family enterprise can be a tricky affair given the different personalities and many other nuances that may exist within this unique environment. Ongoing communication with all of the key stakeholders is critical to the success of the management’s ability to effectively manage risks. Some important tips for fostering alignment amongst family members around risk include:
- Develop a common base level of knowledge in all key stakeholders. Invest in training and development of family, owners and management. A strong foundational knowledge about the business and its industry will provide an educated basis for decision making.
- Ensure good data and information is available to all key stakeholders. Be transparent and open about information relating to the decision and its potential risks and opportunities. Provide timely management information to help all involved paint a clearer picture of the potential upside and downside of the decision.
- Establish useful decision-making criteria. Understand the most important criteria upon which the decision will be based. In addition, perform an assessment using each of the types of risks defined in this article, as well as others you may face. This process will help highlight what is important to those who will be affected by the decision.
- Identify exceptions to nonalignment. Often there is consensus on many aspects of a decision or event and only a few areas of misalignment. Therefore, it is helpful to identify those areas where alignment exists and focus attention on those areas where greater agreement is required.
- Reframe nonalignment. Sometimes misalignment can become a source of tension and conflict from the feeling of “you don’t agree with me.” Name calling and other negative behavior can arise at these times. Instead, try to frame the misalignment as an opportunity to better understand priorities and interests, as well as to build cohesion between those involved.
- Help the family pull back to macro-level thinking. Sometimes risk-related decisions and conversations can take families, management and owners into the weedswhere they lose sight of their vision, goals and the bigger picture. Refocus the discussion by reviewing the higher level strategic direction and priorities.
Fostering alignment around risk starts with having an agreed upon process for making decisions on strategic matters in advance of a decision at hand. It continues with a good set of discussion questions and dialogue related to the family enterprise’s future in order to develop consensus on how to integrate decisions related to what the business needs, the overall family objectives, individual family branch needs and wants, and individual needs and wants. Some of these questions include:
- At what rate does the business need to reinvest profits to remain competitive in our markets?
- What is the risk to our family enterprise and our family if we don’t reinvest adequately?
- What is the risk to family cohesion if we don’t grow the business further to create additional leadership and employment opportunities for family members?
- What constraints do we have that impact our commitment of capital to the family enterprise?
- To what extent do we want our investment in our family enterprise to generate personal liquidity as compared to reinvesting in the business?
- Do we prefer one focused business or more of a diversified business?
- To what extent do individual family members identify themselves with the business?
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Family Business Advisor to multi generation family business across India – Building Family Business Governance for perpetuity.