Scenario: A Challenge to Legacy
Paul Sr., a true entrepreneur, spotted a need in the marketplace for a well-made wicket. Little did he envision the wild success of his enterprise. With this success Paul Sr. realized he could provide employment for his offspring and that one day the business might be theirs. While the eldest sibling of the second generation became a physician, the other three joined the business and over the years became successful managers in their respective departments. Each of the four siblings married and had their own offspring. The ten children of the family managers grew up in a close cousin environment because of their parents’ work hence they spent a lot of time together. The eldest sibling’s three children were less connected to their cousins since they were not part of the business.
At seventy, Paul Sr. began to think about retirement, what to do with the company, and how to structure his estate. He quietly made the decision that since the eldest sibling had done quite well as a physician and he really had nothing to do with the company, a fourth of outside investments would suffice as his inheritance. The other three siblings who worked in the company would inherit their share of the outside investments and would also inherit the company itself. After all, they had helped make the company successful.
Upon Paul Sr.’s death, the three second generation siblings, in honor of Paul Sr.’s vision, made it an ownership policy that only their family offspring who were managers in the company could own it. Unwittingly, this ownership policy challenged the third generation, only one of whom was interested in working in the business. The policy also challenged the cohesion of the family as the oldest of the four siblings and his children grew more distant from their relatives.
Eventually the three second generation siblings chose to sell the business and split the proceeds between themselves. What went awry? Why did another successful family business end at the second generation? Is there an alternative solution to meet the challenge faced by this family business and this business family?
Understanding the Challenge
The above scenario presents some challenges to family business survival which are unwittingly set in place by well-meaning entrepreneurs. Family businesses are defined as enterprises influenced by an owning family. However, if that family becomes disengaged, the business might survive, but not as a family business. The desire to award offspring with employment and ownership of a business needs to be carefully structured and balanced by good governance protocols and practices to meet some of the challenges to family business survival. More and more, family business research, looking at long-surviving family enterprises, is developing a set of best practices and sound advice that promote living legacies lasting multiple generations of five, six, seven and more. So what happened in the above scenario?
Management and ownership became entangled, which challenges both the professionalism of the business and the legacy of the family. In some cases, family managers are hired and promoted not on the basis of their professional competence but rather on the basis of their genes. Further, when ownership is limited to family employees or family managers, the other family members are cut off from the business and from the family legacy. These non-employee family members not only lose their connection to the family business, but also their connection to the family story. Best practice family business research has shown that there is a better way, a way to enable the business to be professionalized and the family to stay together.
Clarifying the Roles
Managers are employees of a business. Owners are investors in a business. In the world of family business, both roles are played by the same people. In fact, in the first generation the founder is the owner and is often the only manager. However, as the business matures and the family expands, more family members enter the business. Several family members can then be playing both roles: manager and owner. What about those family members not in the business? It is at this stage that each role needs to be clearly defined. The employee/manager role should be limited to those qualified in management. The owner role should be inclusive of all family members to maintain the legacy.
In successful businesses, the role of manager is held by professional employees chosen for their leadership role on the basis of their education and proven competence. In a family business, there should be restricted access into management ranks based on the qualifications of family members. Manager compensation usually comes from a basic salary structure with bonuses for outstanding achievement which are funded from the excess of company profits over goals. Family managers should be compensated on the same basis. Just as all employees of a well-run company should be held accountable through professional development plans and annual reviews, family employees should be treated the same. Providing professional accountability for all employees, whether family or not, reassures non-family employees that promotions and compensations are based on merit, not on family genes.
The organizational structure for managers is the management team or executive committee with their focus on the success of the business. In family businesses, such a team should include both family and non-family managers and executives. In larger organizations, oversight for management is provided by the Board of Directors. Managers, even family managers, should not be voting members of their own Board, rather they should report to it. Oversight cannot be adequately provided when one is overseeing oneself! Professionalized Boards also provide invaluable advice and insight to strengthen the company. A manager’s responsibility is to receive this advice and use it in their managerial decisions. Professionalizing the family-manager’s role strengthens the family enterprise.
Family businesses are usually closely held enterprises, that is the owner or owners are family members. A formalized ownership structure usually occurs as the first generation founder-owner gets ready to “pass the baton” to the second generation. At this point of the venture in a family business it is important to consider the ramifications of the role of family owner as investor, as shareholder. Unlike access to employment in the business, access to ownership of the family enterprise should be inclusive of all family members. Such an inclusive policy serves as a way to keep the family together and the family legacy alive. In a family business ownership most often occurs through inheritance because the shares are not openly traded. Compensation for being an investor comes through distributions of some of the company’s profits and through increased share value from the company’s growth and retained earnings. For a family investor, growing and developing into a responsible owner of the family’s business requires education: education about financial matters, education about the business, and education about the family legacy. Responsible owners should be held accountable for their role as investors in the family business. These family shareholders are educated and organized through the Annual Meeting. If the shareholder group is large enough, it might be represented by a shareholder council or committee. Whatever the organizational structure, the annual meeting is a great time to have educational components focused on building sound shareholder knowledge. The family directors, the shareholder council, or the family council can also serve as the oversight group for shareholder accountability.
As discussed above, the roles of manager and of owner are distinct and separate within any business environment. Family businesses are no different, even when some people fill each role at the same time. To aid this effort, two documents in particular are helpful: a family employment policy and a shareholder agreement.
Documenting the Roles
Where to start in the process of writing these two documents is a very individual decision; it will vary in each family business. Two things are most clearly needed for a successful process: supportive company family managers and transparent, open, and honest communication. In all my research, including that of my own family, it was a concerned family CEO who started the process. And after realizing help was needed, an early step in their process was to hire a good guide, a professional consultant/adviser. This does require expenditure of company funds, but as our third generation CEO, James Warjone clearly stated, “Investing in your investors is a wise business decision.” Change is never easy and changing family culture can be challenging at best. Throughout the process, keeping all stakeholders in the communication loop is vital. Good advisers can help through the difficult conversations. Choosing which governance document, the family employment policy or the shareholders’ agreement, to start writing is another decision. What do you have? What is most needed? The most important thing is that by developing these documents through open discussions and many meetings, your business will be strengthened because your family managers will be outstanding professionals and because your shareholders will know and be proud of their inherited investment, the family legacy.