In an ideal world, every family business would have a succession plan that turns the company over to the second or third generation, all of whom have been well-trained to step into a role of their choosing.
Unfortunately, that scenario is all too rare.
“Family businesses often involve emotions, which aren't always best for operations," said Bruce Werner, author of Your Leadership Journey and a family business advisor with Kona Advisors LLC, a consulting firm for privately owned and family-owned businesses. Werner recently consulted with a family business that had been experiencing difficulties after a succession.
“The successors were struggling to keep a $60 million business from collapsing," Werner commented. "We were able to reposition them within the business and salvage the family relationships."
Family succession plans always need to take family dynamics into account, said Gaye Chun, a senior wealth planner with City National Bank.
“Siblings will nearly always have issues with which one is the favorite of the parents and who's in control and who's not," said Chun. “Sometimes you have an extremely dysfunctional relationship with siblings arguing over control. In other cases, even if there's agreement about who's in control of the business there's disagreement about their levels of compensation."
Fortunately, with the help of wealth planners and business consultants, steps can be taken to increase the chances of both family harmony and business success.
Encourage Them to Earn Their Position
A main pillar of success for a family business is preparing kids for leadership as early as possible. According to Werner, this often involves a big dose of tough love.
“It's best if the kids work somewhere else first to learn about who they are and to understand workplace dynamics," said Werner.
Once they enter the business, they should start at the bottom and work their way up to learn the details of the business. If possible, Werner recommends that kids report to someone else in the business rather than their parents to avoid parent-child dynamics.
“The earlier you involve your kids in the business the better," said Chun. “That way they get a chance to know their roles and whether they want to be a back-office person or a CEO."
Use The Three Circle Model to Define Roles
Establishing a governance structure for decision making is also important for a successful family business.
“Family governance is not the same thing as business governance," said Werner. “A good model to explain this is the 'three circle model' developed at Harvard Business School. It's essentially a Venn diagram that shows the different roles of business owners, family members and business managers. It helps people recognize how the roles overlap and who should be making different decisions."
Every family member needs to understand each other's priorities and the undercurrents that can help keep the peace, said Chun.
“If one sibling wants to pour money into the business to grow it but the other has three kids to put through college and wants to pull some money out of the business, there needs to be upfront communication about that," she said.
An independent board of advisors can provide perspective in those situations.
“The important thing for every family member is to come to an agreement," said Chun. “Fighting doesn't benefit anyone except an attorney. It's better to be flexible and keep your family together."
While businesses should have a board of advisors or a board of directors depending on their size, Werner said that family governance is also important.
“A family council should meet to establish policies that relate to the family and its relationship to the business," Werner said. “Then an annual family assembly should gather every relative to educate them and communicate to them about the business. Ideally, that should include what they should expect financially from the business and the rules about what it takes to work in the business."
While there are plenty of examples of dysfunctional sibling relationships in literature, on television and in the movies - as well as in real life - there are lots of successful businesses run by siblings, too.
“Successful family businesses are possible when you define the roles and responsibilities for each family member," said Werner. “You need written agreements about what authority each person has. You should solicit input from your senior staff, who can view the kids' skills and commitments without parental bias."
A non-family member executive can be a key to a successful family business.
“You need someone who, if asked, will give a clear-eyed evaluation of family members involved in the business," said Werner.
If that person doesn't exist, an outside consultant is another option. The important thing is to identify issues and provide professional development for managers in any business, including family members, Werner said.
Chun added: “There's never any one-size-fits-all way to manage a family business. The best way to avoid misunderstandings between family members is to be transparent and keep everyone informed. Involving all family members in the planning, and listening to each other is so important."
If family members cannot come to agreement even with the help of external consultants, sometimes the only option is to sell the business, said Werner.
“There are so many differences in family dynamics, such as whether they are biological siblings or half siblings," he said. “There's also the matter of maturity. Sibling relationships can be very different when they're in their 20's versus when they're in their 60's."
Parental expectations also make a difference in sibling relationships, including families with traditional values that place importance on the gender or birth order of siblings.
“In those cases, one sibling can sometimes be forced into a role that they're not well suited for or have resentment towards another sibling that can impact the business," said Chun.
In many families, only one or two of the siblings wants to work in the family business or is qualified to do so. In that case, a succession plan and estate plan should include a way to balance things out for the siblings who won't be working in the business, said Chun.
“Parents need to decide if their priority is to keep the business going or to prioritize the family by equalizing the inheritance for siblings who don't participate in the business," said Chun. “Families need to think about how to compensate if one child is working to grow a thriving family business while the other is working in another career halfway around the world."
While it may not be fair to split the business proceeds equally in that case, the family may want to find a way to create another income stream or even have special life insurance for the siblings who are not part of the business.
Family business owners need to recognize the differences between their relatives and avoid forcing siblings or others to work together, said Chun.
“This is where a buy-sell agreement or a controlling interest agreement can be valuable," said Chun. “If the siblings cannot get along, they may be forced to sell to a third party."
A buy-sell agreement sets up an exit strategy and establishes a plan in writing for partners buying each other out or selling to a third party.
A “push-pull agreement" is another option to move a family business forward if the owners cannot get along, Chun said.
“In a push-pull agreement, one party lists a price for the business and the other must decide if they want to buy out the party at that price or sell their share at those terms," said Chun. “This forces the person who takes the first step to set a fair price. If the price is too high, they'll be forced to buy out their partner at that level. If the price is too low, they'll have sold their own share for too little."
Running a business for multiple generations requires a commitment to the family and the business by the founders and subsequent generations.
“Training and development of kids to run a business together takes years and decades," said Werner.
Siblings who run a business jointly must develop their own succession plan as early as possible.
“While it may work out that the founders left their business to their two kids who run it competently, one of those kids may have one child and the other may have five children," said Chun. “In that case, there needs to be an agreement about how to divide responsibilities and who has controlling interest."
While splitting a business 50-50 seems reasonable, even that has its perils. Werner has worked with family members who have been arguing about selling the family business for decades. If no one has a deciding vote, the situation can become difficult to solve.
Every business should have a tie-breaker mechanism so that decisions can be made, recommends Werner.
“Always remember that a business can go away but your family will always be your family," said Chun. “The goal should be to keep that family together."
For help setting up your succession plan or managing a succession, turn to professional succession planners at City National Bank. We're ready to help you discover your options when you contact us today.
Kona Advisors LLC is not owned or affiliated by City National Bank or its affiliates.
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