Planning for Family Business Succession and Maintaining Family Harmony
 
April 19, 2006
 

Why should our family continue operating this closely-held business? What value does it continue to bring to our family? These are some of the difficult issues associated with closely-held business succession and the ways that business succession can foster family values while maintaining successful financial operations.*

The transfer of ownership and control of a closely-held business is always difficult because it creates a clash between three sets of values: business, owner and family. For example, one business value premise is that a business should operate as a meritocracy: the best-qualified candidate should always receive the promotion. However, this assumption clashes with traditional family values, which hold that all the children should be loved equally, regardless of any child’s particular aptitudes. By “anointing” one child as the CEO, the parent can unintentionally deliver the message to the other children that they are not loved equally. A third perspective is that the business should reflect the owner’s (or founder’s) identity, and that any change to the business is a challenge to that owner’s legacy and sense of achievement. Added together, these often-conflicting values can create a troublesome mix of competing views that lead many family businesses down the wrong path.

The Key to Resolving These Conflicts Is Objectivity – Not Any Particular Business Structure

A family gains objectivity when it sets forth ground rules for business operations as described in the following three strategies and standards.

First, the family must establish a mutual set of values and culture so that people with differing views can work together. Indeed, these mutual values and culture give private companies a significant competitive advantage over public companies. All family members must agree about what it means to own a family business. It involves a passion about the business, a furthering of family values, stewardship (both of family wealth and of nonfamily employees) and an understanding that ownership doesn’t equate to a right to liquidity. In short, owning a family business is more than a financial undertaking – it’s a mission. All family members must agree to this mission for the business to continue to thrive.

Second, the business must have objective standards for family members who want to work in the business. For example, a family member may have to work somewhere else (perhaps for a competitor) for a set period of time or until that person receives at least one promotion. The older generation also must make sure that the younger generation receives the appropriate mentoring in the business without the overlay of family emotions. This usually means that the mentor should be a key employee who is not a member of the family.

Third, and perhaps most important, the family must balance the interests of family governance, business governance and business management. This is particularly true where there are family “insiders,” who own equity in the business and who also are involved in management; and family “outsiders,” who own equity but have no say in management decisions.

Family governance can be covered by a family advisory council, which has as its purpose providing family input to business management. Such a council can, in larger families, be made up of separate “subcommittees,” which can address everything from family employment policies and family education to family philanthropy as well as vacations and assemblies. This allows the “outsiders” to have a significant family role and provide input to management.

Business governance is undertaken by a board of directors, which can be made up of family members, outsiders or both. Business management, the day-to-day operations of the business, also can be conducted either by family members or by outside management. The involvement of outsiders in business governance and management can be critical to the success of the business for two reasons. First, the outsiders can provide some of the objectivity needed to balance all interests. Second, the business must provide opportunities for employees and nonfamily shareholders or it can become stagnant. A common number of outsider directors on the company’s board is three, because if all three outsiders agree on a given point, it provides some perspective and some weight to a given position.

Effective ownership and succession of a family business truly depends upon many factors. All family members must constantly study and learn about the family business and the industry in general. They all must have an appropriate level of participation, if not in the business, then in some kind of family board that allows them to have a voice that is heard by management, or even better, by a board of directors. Family members also must share in the mission and vision of the business, and not view it merely as a birthright that generates cash flow. Finally, the business must also consider the economic and emotional needs of the family.

To conclude, Stephen McClure* (citing the original work of his partner, John Ward) summarizes all of these points in 15 guidelines for managing the succession process:

1. Succession is a process – not an event. The process of succession begins with the communication of business issues between the owners and their children at all ages. This communication should include not just the nuts and bolts of the business but should also convey a sense of the owners’ passion for the business.

2. Present the business as an option – not an obligation. Not all children need to participate in the family business. Involvement in family governance or the family’s philanthropic efforts may be enough. The key is to make sure that each child is involved in the family in some way so that no one feels left out in the cold.

3. Get outside experience. Such experience should be derived from working for other people before working for the family business. This outside work can last from three to five years and ideally would be in the same industry.

4. Hire into an existing job. The business should not create new jobs with unclear descriptions simply to keep a child or family member employed. By hiring into existing jobs, the owner not only creates objective standards for the family member’s performance, but also lets the nonfamily employees know that family members have to play by the same rules.

5. Encourage the development of complementary skills. For example, if the parent and owner is a great salesperson, the child may want to bring operations or information systems skills to the business. Coming out from under a parent’s shadow is important for a child to succeed at the business.

6. Teach the foundations. This includes ensuring that the older generation teaches the next generation about the historic, cultural and strategic foundations of the business. This education gives the younger generation a sense of the underlying principles that hold the business together. It also involves passing on the passion for the business and a thorough understanding of the industry in which it competes.

7. Start with mentors. Children should not work for parents but rather for a valuable, loyal, secure and long-standing nonfamily employee, one who can teach the business values but does not have a familial relationship with the child.

8. Designate an area of responsibility. New family employees should have a well-defined area of responsibility; this is a counterpart to putting the child into a well-defined job and to encouraging the development of complementary skills.

9. Develop a rationale. Both the founder generation and the successor generation need to create a statement that explains why this difficult transition is worth it. Remembering the rationale for this change helps families get through the rockier periods in the transition. Just as the business itself needs a mission statement, so too does the family need to remind itself what this business means to the family.

10. Recognize that the family is not alone. Every family has difficulties settling these issues. Conflicts between parents and children are universal, as are the behaviors of first-born children and younger children. Just as the family bears in mind the rationale for making the transition, it also must bear in mind that the family’s behaviors are less idiosyncratic than it thinks.

11. Have family meetings. Family meetings should allow the whole family to discuss important matters, perhaps by selecting a topic and moderator in advance. There should be communication, not simply mandates coming from the older generation. These meetings can take place at the office, but they also can be very successful if located at a vacation spot, giving the family not only the time to talk about the business, but to play together as well.

12. Plan, plan, plan. Long before the succession actually takes place, the founders should write a business plan, an estate plan and a succession plan simultaneously. Although difficult to do, integrating these activities will make each more powerful and more likely to succeed. Also, these planning documents need to be reviewed periodically to ensure that the plan implemented by the founders still makes sense for the family in light of changed circumstances. Even such dry documents as buy-sell agreements and shareholder agreements are a statement of family values.

13. Create an advisory board. Such a board might include outside lawyers, accountants or organizational specialists, as well as one other person from the business’ industry that the owner respects. This group can provide the objectivity necessary for an effective succession to take place.

14. Set a date. This is the date by which the succession process should be terminated and the business handed off to the next generation in whatever manner the family has agreed to. The founder must be fully committed to that date, the staff must be aware of it and the successor must be able to depend upon it.

15. Let go. Finally, the founder at the end of the process must not go back on his or her agreement. The founder must let go of control of the business and allow the plan to move forward, even if it endures rocky periods.

* These and other questions were addressed at a Family Business Seminar held in Portland, Oregon, that was hosted by Holland & Knight’s Private Wealth Services Group. Five of the firm’s wealthiest Oregon-based clients joined lawyers of Holland & Knight’s Private Wealth Services Group and Stephen McClure, a principal of the Family Business Consulting Group, Inc., for this seminar.

For more information, e-mail Christopher P. Cline at chris.cline@hklaw.com or call toll free, 1-888-688-8500.