Protecting the Family Business Legacy

(Thoughts from James Baka – TEC NextGen 1 Chair – Jim is also an Adjunct Professor and has developed and teaches a Family Business Studies Minor at Concordia University Wisconsin and he consults with family businesses – especially regarding family conflict and the need for effective succession planning. He is also the founder and chairman of the Family Business Legacy Institute – fbli-usa.com)

Family businesses must continually ask themselves how do we protect the Legacy of our Family Business. Given the devastating failure rate of next generation companies the family must absolutely continue to focus on the following questions.

So what is a family business and what makes it so unique – the family business constitutes the whole gamut of enterprises where an entrepreneur or next-generation CEO and one or more family members influence the firm through their management participation, ownership and control, strategic preferences, and the culture and values they impart to the enterprise. It is unique because of:

  • The presence of the family.
  • The owner’s dream to keep the business in the family—the objective of business continuity from generation to generation.
  • The overlap of family, ownership, and management, with its zero-sum propensities in the absence of firm growth.
  • The unique sources of competitive advantage derived from the interaction of family, management, and ownership, especially when family unity is high.

 

So what are the economic impacts of family businesses in the United States and the rest of the free world countries – Specifically family businesses:

  • Constitute 80 of all businesses in the United States and more than 90% in the rest of the other free economies.
  • Generate 64% of the GDP in the United States and more than 75% in many other countries.
  • Employ 85% of the private sector U.S. workforce and more than 90% of the working population around the world.
  • Created 86% of all new jobs in the United States in the last two decades.
  • There are 17–22 million family-owned businesses in the United States.
  • Approximately 35,000 family businesses have annual revenues exceeding $25 million.
  • 35% of S&P 500 companies and 60% of all publicly-held U.S companies are family-controlled.

 

 

What are common challenges to governing the family business relationship?

NepotismWhile nepotism is arguably the most widely stereotyped feature of family business and as stereotypes often do probably exaggerates its impact, there is no question that a family-first attitude in selecting managers and employees for the family enterprise is a significant challenge to governing the family-business or family-wealth relationship. When last name and not merit are at the heart of the selection process in the firm or family office, the message sent is loud and clear: family logic and not economic, value-creating or business logic is in command.

Loss of family identity and values – Family values, family legacy and the renewed sense of purpose brought on by a multigenerational family vision are the anchors of an enterprising family’s continuity plan. But these often erode as families grow in number and wealth.

Family conflicts Speed is one of the competitive advantages inherent in entrepreneurial firms resulting from the overlap of ownership and management. But in later generations, a family that is paralyzed because of conflicting views across generations or across branches of the extended family can become inward-looking and fertile ground for turf wars. In the process, a family business can forget its most basic comparative advantage in relation to often larger, more global, and bureaucratic corporations–its nimbleness.

The belief that fair means equalNot all of the children want the same thing for their future. So equal is not fair. One of the heirs may want to start a company instead of working in the established family business. The inherited family business had a couple of years of reduced profits and dividends which put this son’s plans at risk.

Current leader’s unwillingness to let go – The critical and urgent need to build institutions of family governance is often lost on the family CEO. In a study conducted by the author, the most statistically significant finding was that CEOs of family businesses perceive both the business and the family much more favorably than do the rest of the family and nonfamily managers. In the absence of expressed dissatisfaction with the status quo, the CEO/parent may be the last to recognize the urgency of leading change efforts and creating the institutions that will effectively govern the family–business and family-wealth relationship in their absence

Entitlement culture– Another significant challenge from wealth and enterprise to multigenerational families is the entitlement culture, an unsustainable culture of acquisition and consumption. Warren Buffett is credited with a principle that aims to curtail its harmful effects on families: “Give each child enough money so that they can do anything, but not so much that they can afford to do nothing.” Families that develop a list of principles that guide their relationship to wealth and enterprise and capture them in a family constitution are also proactively governing the family and leading it towards responsible stewardship of its business.

Dilution of wealth – Besides the erosion that may result from unnecessary expenses, taxes and a culture of entitlement, distributions and the break-up of the business or the pool of family capital can negatively affect the family’s access to new investments and to the financial resources needed to take advantage of a wide range of business opportunities. A smaller capital base is also offered fewer and often less promising investment opportunities.

The erosion of the entrepreneurial cultureThe entrepreneurial stage is widely recognized as one that endows the business with the capacity to be nimble and opportunistic. But it does not take long for successful family businesses to be expected to comply with standard accounting principles that promote greater transparency – and the accompanying paperwork – and to have to comply with a growing number of industry standards and government-initiated requirements. Increased regulation and the expanding need for coordination create the impetus for more meetings, more memos and more e-mail that make the business of the family naturally become more bureaucratic and risk-averse.

Insufficient professionalization and institutionalization of the family’s enterprisesWhile rampant nepotism often precludes professionalization, even without nepotism, family firms can suffer from the inability to change, delegate and institutionalize a successful business model beyond the founding generation.

Professionals bring different competencies, skill sets and perspectives on the strategy and tactics to be used. And since no family has a monopoly on the knowledge and skills needed, professionalization is a fine complement of the family’s role in the enterprise. Notice that the argument is not for replacing family employees with nonfamily “professional” employees but rather to increase the professionalism of family employees and complement it with the professional knowledge and skill sets of nonfamily employees.

Lack of transparency – Neither boards of directors nor professional managers can make their value-adding contributions to family business without good metrics and clear scorecards. Shareholders themselves can seldom act as responsible shareholders in the absence of financial knowledge and financial controls. While entrepreneurial cultures often resist the call for greater transparency, after all the founding entrepreneur stayed on top of everything, next generation leaders are well served by investing in professionally assessing the pulse of the enterprise in real-time terms. Lack of transparency can also give rise to an absence of caring for the business within the extended family. Absent caring, continuity is threatened.

Lack of oversight – Lack of oversight, by for example an independent board of directors, often breeds complacency and resistance to change. It may also lead to self-dealing and giving some shareholder’s interests priority over that of all shareholders

AltruismResearch has found that altruism, or attending to the welfare of a relative, is a prominent feature of many family enterprises. Some scholars have argued that altruism represents a form of agency problem that often leads family firms to make decisions that are economically irrational. And while it may be true that what is irrational to some is perfectly rational to an owner family aiming for maximum utility from its relationship with an enterprise (which includes reputation, family benefit, family emotional well-being, and other nonfinancial objectives), altruism presents the risk of incurring principal-principal agency costs that are unsustainable long term by the family enterprise.

Wanting to keep it all in the familyPublicly traded firms, through their capacity to create a market for corporate control, hold management accountable. The market for corporate control makes top management accountable to all shareholders. The absence of the equity markets’ influence prevents this disciplining function in privately held family firms. Even family business that are publicly traded, by definition, have an overriding measure of family control.

In the absence of market-induced accountability, owning families have to step up, and in collaboration with their family council and board of directors, hold top management accountable to all stakeholders’ interests.

What policies are families encouraged to develop, before the urgent need arises during succession, in order to beat the low odds of family-business continuity?

  • A family constitution that may be the umbrella for all policies governing the relationship between a family and its business.
  • A family participation policy that includes an employment policy, board service policy, and subcontractor relationship policy.
  • A financial needs and ownership transfer preferences policy that addresses liquidity and dividend preferences and guides the development of liquidity funds and buy–sell agreements between shareholders. Legal documents such as shareholder agreements should offer liquidity windows that are triggered by events other than the death of shareholders.

What are next-generation leaders best-suited to do on behalf of long-term success and continuity?

Next-generation leaders in family firms that are successful in the long term are very aware that their motto is partnership. They are cognizant of the fact that they serve the company and the family and may provide the spark for a renewed but collective effort on behalf of the business and the family.

The next generation provides the customer-driven vision that promotes innovation and regenerates the company and creates a partnership with:

  • Other family members through the family council, family meetings, shareholder meetings, and hundreds of informal conversations that inform and educate.
  • Key nonfamily management through top management team, operating committees, etc.
  • Boards of directors.
  • New members of the ever-changing family supply chain.

 

Why are family-business CEOs often an obstacle to the very succession and continuity efforts they so prominently subscribe to?

CEOs perceive the business and the family much more favorably than the rest of the family and nonfamily managers. Various scholar findings indicate that in the business, CEO-parents perceived business planning, succession planning, communication, growth orientation, career opportunities, and the effectiveness of their board significantly more positively.

On the family front, these same owner-managers were more satisfied with how family member employment and participation in the business were being handled. CEOs perceived greater clarity and understanding among family members of succession standards and processes and the manner in which the estate and business ownership would be transferred across generations. CEO-parents also perceived the relationships among family members more positively and considered that the expression of differences was encouraged to a greater degree than other family members.

These are not surprising findings given the tremendous autonomy of family-owned business CEOs and how little performance feedback these CEOs generally receive from both family members and key nonfamily managers that report to them. The power implicit in being the top manager, principal owner, and head or partner of the family reduces the access and changes the nature of the information provided the CEO-parent.

In all of the differences detected, CEO-parents had a more positive perception than younger members of the family, particularly those 41 to 50 years old, working in the business. CEO perceptions may be skewed by their own success, and they may have difficulty seeing problems in the midst of what they created and continue to run. Their positive bias may, then, implicitly at least, mean that they are also much less likely to experience sufficient dissatisfaction with the status quo to want to change anything, even if it is on behalf of family-business continuity. This may thwart efforts to promote the readiness of the next generation and build the necessary institutions to govern the relationship between the family and the business in the future.

Transferring power has never been easy in any setting

For many, power is as much a life force as the need to achieve and love. In the family business, it is further complicated by the tugs of family relationships and the sheer power of ownership. In other words, transfer of power in the family business is not just a matter of passing the managerial baton on to the next-generation person, as it is at GE, but also passing on the flaming torch of family leadership and the golden mallet of ownership control.

Most of the stories of failed successions in privately held and family-controlled companies reflect the difficulty of doing all three within a reasonable period of time.

What can CEOs do to lead their companies into successfully transferring to the next generation?

Building a top management team with nonfamily managers on it, creating a board with independent advisors or directors on it, and starting a family council or shareholder group with active governors constitute the best institutions to ensure the effective transfer of power.

Why are boards with independent outsiders deemed so important to family-business competitiveness and continuity?

Outsiders with a commitment to the company can add perspective, problem-solving ability, expertise, strategic thinking, and a network of contacts that complement the able CEO and top management.

Different visions of the future between generations and predictable differences between family members that are active in management and those that are not can use the facilitating, moderating, cajoling, and professionalizing influence of a board.

 

What unique advantage does strategic planning offer the family-owned business?

Strategic planning increases owners’ and managers’ awareness of changes in the competitive environment and promotes much-needed communication among shareholders. With its natural bias toward growth, strategic planning is a great antidote to the challenges of the late maturity and decline stages that many family businesses find themselves in as they confront succession.

In the absence of growth, family businesses become very vulnerable during the succession process. The zero-sum dynamics that are unleashed as the family grows, if the business does not, are a precursor to both business failure and disharmony among family members.

Why is a mature family-owned business, one often facing the prospect of succession, so vulnerable to decline and failure?

From a strategic perspective, family-owned enterprises are most susceptible to accelerated decline and failure precisely because of their own reliance on the individual entrepreneur or next-generation CEO. The hero, who founded and led the young business to accelerated growth, displays a natural disdain for organizational architecture, and for establishing systems, professional managerial practices, and governance mechanisms. While not always the case, next-generation heroes often exhibit some of this same disdain for managerial discipline as they engage in the strategic regeneration and growth of the business. Professional managerial practices are, after all, considered the relatives of bureaucracy; bureaucracy is the dreaded disease the privately held company CEO fled from in the world of publicly owned global behemoths.

When a family group is added to the equation, that is, when multiple members of a family become active in management and/or engaged as shareholders in thinking about the future of the enterprise, disagreement, conflict, and, as a result, paralysis often set in. The different perspectives on conflict and the different tolerance for difference held by active and inactive shareholders, as found in the Discovery Research for Family Business project, makes strategic planning a task to avoid.

The survival statistics for family-controlled enterprises are alarming. Entrepreneurial firms have a dismal record of preserving the spirit of innovation that started them and propelled them through maturity. What lies beyond the exciting and exhausting start-up or regeneration and growth phases of each generation is organizational maturity. Maturity may be wise and may certainly feel like a well-deserved stage where there is wealth, influence, and a feeling of finally having “arrived.” But under the veneer of plenty lies the greatest risk of accelerated and protracted decline and eventual sale or death of the enterprise.

At this stage, the business has become a complex set of stakeholders or audiences: the banks that have financed the growth, family members who have worked summers in the enterprise since high school, key nonfamily managers who have substantially contributed to the success the business has enjoyed, other branches of the family with a financial and/or emotional interest in the enterprise, other investors, employees, and the government. And each of these stakeholders has a different perspective on the enterprise and feel entitled, for different reasons, to what they want from it. Like running an election campaign by poll results, leaders of family-controlled enterprises overwhelmed by the complexity of their audience often lose sight of that visceral sense of vision that was so much a part of the young organization. The absence of this vision often sets the stage for decline.

Why is strategic thinking and strategic planning so often avoided in family-owned companies?

An entrepreneurial culture built on moving towards opportunities with great agility is often not receptive to the more administrative, perhaps even bureaucratic, orientation that strategic planning activity demands. In later generations, even if the founding entrepreneur is no longer around, the culture may still value its healthy skepticism towards management and administration.

Beyond this reluctance, there is in later generations a hesitation to face the potential for conflicting views of the future that different owner-managers and family members may have. Fear of conflict emerging in the difficult conversations about the desired direction for the future of the business leads many family-business leaders to avoid the communication and planning activity that can paradoxically build a bridge across these differences and provide for both business continuity and family unity.

How can growth resulting from entrepreneurship and competitive advantage help the next-generation leader create a platform for positive-sum dynamics in the family and therefore enhance the prospects of continuity?

Growth creates new business and career opportunities for both family and nonfamily managers. By creating these opportunities, the organizational culture is enhanced and family unity promoted. Patient capital is more likely to remain patient in the face of an attractive future and long-term strategies that promise adequate returns on shareholder capital. The win–win dynamic established by creating value for the customer, creating value for shareholders, and providing opportunities to family and nonfamily employees in the firm creates a myriad of possibilities for the next (and larger in numbers) generation.

Why are nonfamily managers critical to the survival and continuity of the family business?

Nonfamily managers often bring with them skills that do not exist in the family. A technically oriented business-owning family, for example, may lack the financial expertise needed as the company grows. But perhaps the largest contribution that nonfamily managers make is establishing a standard or benchmark of what constitutes professional management. In so doing, they enable a business-owning family to establish criteria for family-member participation in the business and to discourage the extreme forms of nepotism that a family dynasty (versus a meritocracy) may promote.

Nonfamily managers are often better suited to lead a fundamental change effort in the company, when one is required, than family managers. The absence of familial ties and the perception that they are more objective (and less tainted with history and traditional ways of doing things) serve them well in acting as change agents.

The very presence of nonfamily managers in the top management team also often promotes an appropriate differentiation between family and management that lays a foundation for good governance of the family-business relationship.

What are the biggest challenges to nonfamily management retention and motivation?

The biggest challenges to nonfamily management retention and motivation include the perception that career opportunities may not be as readily available as in other companies and that compensation is not as equitable as in public management-controlled firms is a critical one to manage.

Certainly feelings of lack of inclusion (in setting the direction for the firm, succession planning, etc.) also erode the nonfamily manager’s commitment to the business. Including nonfamily managers in strategic planning, inviting them to report to the board on priority projects, and making them a part of the extended family culture goes a long way to allay these concerns and truly make nonfamily management a resource to family-owned businesses.