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NC_OLD1030: Family Firms and Policy (NE167)

Statement of Issues and Justification

Family owned firms comprise the majority of firms in the United States (Heck & Stafford, 2001). The economy depends on them. Family firms generate over 50 % of the gross business revenue in the U.S. In 1996 family firm owners created 69.9 million jobs, reflecting 54.8 % of all American jobs. Family firms dominate agriculture, wholesale, and retail sectors of the economy, indicating substantial impact. On the other hand, large numbers of firms close before their fifth year of operation. Given the heavy dependence of the economy on these small family owned firms, ascertaining what is associated with their survival and growth, and identifying the effects of policies on them is vitally important.

The economies of rural areas are more dependent on family owned firms than other regions. The Midwest, for example, is more dependent on farming and ranching. At the same time, family owned firms have a disproportionate impact on the economy of the Midwest. Family owned farms are family owned businesses. Also, most farm families have at least one off-farm job, and the majority of these jobs are for family owned firms. In other words, rural areas have economies that are dependent on risky enterprises. The majority of family owned firms are also small. Small firms have a lower success rate than larger firms and are inherently riskier enterprises. Farms are also risky enterprises. Given the heavy dependence of rural communities on such enterprises, ascertaining what is associated with family owned firm sustainability is particularly important for rural America. The well being of rural communities and their citizens is closely linked to the health of locally owned family firms. A relatively large number of family-owned firms are located in rural communities and the owners were residing there before they owned the business. Thus, the challenge is not convincing rural Americans to start firms, but how to grow these firms and prevent business closure. However, these firms have a short average life span and the majority is small or very small. Thus, it is vital to identify predictors of family firm survival and success and understand the role policy can play.

The Internal Revenue Service lists U.S. non-farm business receipts for 1996 at approximately $16.8 trillion (U.S. Census Bureau, 1999). According to the 1997 National Family business Survey (NFBS), non-farm family firms generated $8.6 trillion in gross revenue in that same year. Using these figures, family firms produced 51 % of all business revenue. Of the $8.6 trillion, $3.5 trillion was generated by non-agricultural firms in rural areas. Nonagricultural family firms were responsible for the majority of corporate receipts and all proprietors business income in 1996. The impact of these firms was greatest in the Midwest and least in the Northeast, although their economic impact was substantial throughout the U.S. In all regions, their economic impact was greatest in rural areas.

Family firms dominate some sectors of the economy, particularly the wholesale and retail sectors. Agricultural family firms are evenly split between farms and other businesses. Almost all farms are family owned. According to the United States Department of Agriculture, only 1.4 % of farms are not family owned (U.S. Census Bureau, 1999). Measuring farm income is particularly inexact because of government price support programs, but it is clear that family firms account for most of it. Family firms also generated 75.4 % of business receipts in the wholesale and retail sector. The 1997 NFBS classified firms according to the 1995 North American Industrial Classification system (NAICS) developed to monitor trade under the North American Free Trade Agreement. Family firms in the wholesale, retail, storage and transportation sectors generated $5.1 trillion of the $6.8 trillion attributed to all firms in these NAICS classifications (U.S. Census Bureau, 1999). Family firms have least impact on the education and health sectors of the economy. According to the 1997 NFBS, family firms generated only 9.6 % of the revenues in the same sectors.

Another measure of economic impact of family firms is job creation. If business managing owners are included in employment statistics, family firms employed 62.5 % of civilian employees in 1996. Employment statistics are categorized as agricultural jobs and nonagricultural jobs. Family businesses generated 97 % of agricultural jobs and 52 % of nonagricultural jobs in 1996. In the 1997 NFBS, non-farm agricultural firms employed 3.3 million people. As firms grow they logically employ more people.

Family businesses are not only engines of economic growth, but they are critical players in the social and political development of communities. Another measure of the impact of family owned firms on the community is leadership the owners provide and the donation of time, goods, and services to local institutions. A recent study by the National Federation of Independent Business (NFIB) found that 91 % of small business owners contributed to their local communities by volunteering, donating cash or making in-kind contributions (Dennis, 2004 b). Nearly 75 % said they volunteered at least 12 hours a month. In the National Family Business Study 2000 Panel, 41 % of rural family firm owners had served in a community leadership position. Between 1997 and 2000, at least 65 % of rural owners had contributed financial or technical assistance to community development efforts. In that same time interval, 91 % provided donations to local schools and youth programs.

Older businesses owned by individuals with more human capital are most likely to make substantial contributions of time to their communities, especially in more economically vulnerable rural areas. Bessers (1999) study of small town business owners found that the owners of older businesses and those with more employees were more likely to be committed, and provide leadership to the community. Further, the owners education and age were positively related to leadership. Owners were also more likely to demonstrate community commitment than business managers. In another study of small town business operators, Besser (1998) found operator education, business age, and collective community action to be significant predictors of community leadership. Fitzgerald, Haynes, Schrank and Danes (2005) found that individuals with very positive attitudes about their local communities were more likely to serve in leadership positions and make financial and technical contributions to the community. In addition, individuals with more education were more likely to participate as civic leaders in elected or appointed positions, while individuals with more household wealth and profitable businesses were more likely to provide financial and technical assistance to their communities. In addition, business owners in the most economically vulnerable communities were most likely to provide technical and financial assistance.

Vital, vibrant communities depend on successful family businesses. Policy makers must recognize the many contributions of family businesses and forge rural development policies that not only help sustain existing businesses and fuel engines of economic growth, but encourage human capital development. Successful businesses depend on support from healthy families. A community culture of businesses and families pulling together for the collective good of the community is critically important. Family businesses are the cornerstones of many communities, creating income and wealth for their owners and employees, donating to local organizations, providing civic leadership and making other contributions. Moreover, more financially successful households and businesses are more likely to make substantial financial contributions to communities, especially those in more economically vulnerable areas.

Many businesses do not survive more than five years. This lack of survival is often attributed to poor business management such as timing of the launch, location or inadequate financing. Personal and family reasons also account for business closures. Natural and manmade events are another reason for business closure. In identifying effective policies to encourage entrepreneurship it is necessary to account for these correlates of business success or failure. Businesses are most likely to close within a year of opening, the launch period. Many businesses that survive their launch period close at a later date. The most frequently researched reasons for success and failure are business management practices. In the NFBS 2000 Panel, financial problems were also one of the major reasons for business closure. Financial problems were indicated as a major non-personal reason for business closure. Olson, Zuiker, Danes, Stafford, Heck and Duncan (2003) found that business characteristics and the owners business management practices accounted for most of the variance in business gross revenue, the most common measure of business success. Another frequent reason for business closure or success is the family. Many small businesses survive because the family works without pay or uses family assets to secure a loan. Olson et al. (2003) found that the family and how the family managed the interface with the business accounted for 22 % of the variance in business gross revenue and 33 % of the variance in perceived success of the business. In the NFBS 2000 Panel, 69 % of the respondents who had closed their business between 1997 and 2000 did so for personal or family reasons. In rural areas personal and family reasons were even more prevalent motives for closure. At least 74 % of those who closed their business did so for personal or family reasons.

Some businesses also close due to unexpected disruptions for which they are unprepared. These disruptions may be due to natural or man-made disasters. As we have seen in the recent aftermath of hurricane Katrina, the cost of this type of business demise has a ripple effect far beyond that of the loss of the individual business. Jobs are lost, other businesses suffer revenue losses when employees lose jobs, fewer tax dollars are collected, and the normal four to seven turns of a dollar in the community is greatly diminished. Clearly, the successful survival of households and businesses is an important key to the successful survival of a community. According to Herbert Mitchell, Associate Administrator, Office of Disaster Assistance, Small Business Administration, as many as 40 % of small businesses directly hit by a serious natural disaster like hurricane Katrina do not survive (Dennis, 2004 a). According to Brown (1993), 80 % of businesses surveyed in Europe and America that lack a crisis plan and testing of it go out of businesses within two years after suffering a major disaster. Hiles (1992) contends that 70% lose business efficiency within the first two days of a disaster and can lose three quarters of their business as a result.

An NFIB study reported that at least 30 % of respondents had been closed at least 24 hours in the previous three years because of a natural disaster. Of those businesses experiencing a natural disaster within the previous three years, 62 % reported that the biggest problems were loss of sales and customers, and uninsured losses (Dennis, 2004 a). Lack of adequate insurance coverage had a significant impact on the ability of the business to continue. Extreme impacts of natural disasters tend to be highly concentrated and were defined as resulting in closure of a week or more and losses or damage of $100,000 or more. Only two to three % of small businesses reported extreme impacts. The most common reason for closure was related to extreme cold, ice and snow. Others experienced closures due to other weather events. The most destructive events were wind-related, tornados, hurricanes and typhoons. Fires, extreme heat, earthquakes, landslides and sink holes resulted in minimal closures.

Many disastrous business disruptions are man-made. Before the explosion at the Murrah Federal Building and the terrorism experienced in New York City and Washington, D. C. on September 11, 2001, most executives and owners anticipated that their worst nightmare would be an earthquake, tornado or loss of a building to fire. Few had considered that business necessities such as electrical power, telecommunications and transportation would be disrupted, or that thousands could die in a single catastrophic event. Since September 11, business continuity and disaster recovery have gained in importance (Chabrow & Garvey, 2001), yet many businesses are still unprepared for major disruptions.

Man-made disasters were reported by 10 % of the surveyed businesses in the NFIB survey (Dennis, 2004 a); these were primarily terrorism related. Twelve percent experienced economic disruptions such as highway construction, road re-routing and urban renewal. Most reported that they had not been notified of such changes. One-third were impacted by computer viruses. Twenty-one percent experienced power losses for at least 24 hours and often the loss was not weather related. Twenty percent had backup power sources such as a generator. Only 38 % of the surveyed businesses had emergency preparedness plans and most of those had communicated it to their employees. The remaining 62 % were gambling that their businesses would not experience any sort of disruptions. Other types of man-made events or shocks to the community that are outside of the control of the community include the loss of a health care system (Doeksen, 2000), globalization (CSREES, 2001), the changing nature of traditional agriculture (Drabenstott and Sheaff, 2001), rapid, nearly uncontrolled growth or rapid out-migration, declining tax bases, lack of available capital (Drabenstott, 1999), and the lack of local leadership (Beaulieu, 2001).

Regional Research Project NE 167 has demonstrated the feasibility of finding and interviewing a random sample of family owned firms using a household sampling frame and obtaining a high response rate. NE 167 also successfully interviewed a stratified random sample of 708 family firm owners. As Heck and Trent (1999) noted, the response rate was over 70 %, even though the interviews were 45 minutes long. For 673 families, two interviews were obtained, one for the business owner and one for the household manager. That project also obtained a relatively large number of interviews from rural locations. NE 167 also successfully re-interviewed participating business owning families in 2000 (Winter, Danes, Koh, Fredericks & Paul, 2004).

It remains critical to conduct this research as a multi-state effort. A multi-state effort increases resources available to conduct this research and improves the generalizability of results. As noted, family business success and failure have multiple antecedents. Collecting data from many states yields data that have sufficient variability, allows for control of antecedents, and the identification of effects attributed to policies, families, and business management practices. Without results from the proposed project, we will continue to make inferences about entrepreneurship, policy, and community economic development based on research that ignores the critical role of family in business survival and growth. Results from the 1997 NFBS and NFBS 2000 Panel have demonstrated the undercounting of family firms when business sampling frames are used. These two data sets are also the only data sets on family or private firms that are generalizable and contain data about the family and its effect on the business. Using samples that omit very small businesses and ignoring the effect of the family both yield estimates that are biased. It is evident that studies using business and household sampling frames, as well as family and business related variables, are needed to advance research on rural and community development.

Successfully completing the proposed research will provide useful information for family firm owners, economic and community development officials, and policy makers. The results of this research will provide information to business-owning families that will enable them to improve their management practices. Results will also provide economic and community development officials with estimates of the impact of these businesses on their communities and will allow more effective assessment of the costs and benefits of proposed actions. Policy makers will additionally gain estimates of the impact of a select set of policies on family firms and, indirectly, on communities and economies.

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