Niki Lauda’s lessons in risk-management

Niki Lauda in his Ferrari in 1976
Niki Lauda in his Ferrari in 1976

In 1976 the racing driver Niki Lauda crashed his Ferrari racing car and almost died in a fireball. Just 42 days later he got back behind the wheel to race in the Japanese grand prix in a race that would decide who won the Formula 1 championship. In heavy rain, Lauda quit after a few laps, telling his team that he had reached his risk threshold. “I accept every time I get in my car there’s 20% chance I could die” he once said. Once the odds got worse, he went home.

Rare is the person who can evaluate risk so as accurately as Niki Lauda (who, incidentally, came from a wealthy family of Austrian industrialists and went on to run two airlines.) And the more variables that are involved, the harder it is to assess. For organisations as complex as family businesses – which have to make sense of operating businesses, family offices, foundations, succession, family affairs and more – quantifying risk is a mind-boggling matter.

It’s not surprising, then, that according to a report by Crystal & Company, a third-generation family-owned risk and insurance advisory firm, families are not doing enough to manage their risk. While 95% of family firms surveyed said they were aware of the risks facing then, just two-thirds have “taken steps toward implementing a plan to address specific areas” and only 30% had a risk-management plan that involved risk to the family itself. There is “siloing of risk”, so that risk is assessed separately by the family business, family office or specific family branches. A full-time risk-manager who oversees all the family’s affairs is advisable, said the report.

That is all very well, but keeping up with the risks facing families is a bit like playing whack-a-mole: new ones spring up all the time. A recent article by KPMG pointed out that younger family members could spread information on social media which could damage the business, or the family’s reputation. Divorce can also damage the business if it means shares go to someone hostile to the family. Teaching Twitter etiquette and drawing up watertight prenuptial agreements, then, are part of a modern risk mitigation strategy.

And not all family firms have the same risks. A book written by a trio of Spanish academics following interviews with 1,500 Spanish family firms argued that a family business needs structures appropriate to its complexity, or it risks family affairs ripping the business apart. As they grow, families need to write more down and sometimes to consolidate the number of family shareholders. Not to do so is to take a huge risk.

But aren’t family firms inherently conservative and risk-averse? There is some evidence for this. A 2010 study by Stern Business School academics of S&P 500 listed firms found that family businesses were managed with less risk and were overall more financially healthy than non-family ones. Although their capital structures were not different, their operating businesses were run more prudently, for example they retained more earnings. As a result, a smaller percentage of the businesses in the study’s sample went bankrupt in the year of the financial crisis, 2008 (13.3%) than in the boom year of 2006 (26.5%).

A further complication is the variation in risk-tolerance between generations. The founders of successful businesses are famously risk-averse with the money they have amassed. However those in the third generation onwards, who have no personal memory of the building of the business, tend to be willing to take far more risks with the money. It stands to reason that they might have the same attitude to their operating businesses.

Of course, it’s not always true that risk-aversion is best and firms sometimes have to take risks if they are to survive. Take, for instance, the family-owned French saddlemaker Hermes which saw which way the wind was blowing and in 1918 acquired the exclusive rights to use the zip-fastener in France and moved into high-end clothing. Few other saddlemakers made such good bets.

Family firms might well need people to oversee all the risks their businesses and families face, but anyone tasked with the job might envy the simple life-or-death decisions that racing drivers have to make.