Perpetuating the Family Business

John L. Ward’s “50 Lessons Learned by Successful, Long-Lasting Family Businesses” (published in 2004)

Context

• 40%+ of all companies globally are experiencing a succession process; ~50% of U.S. family firms will be co-owned / led by brothers and sisters
• “Shirtsleeves to shirtsleeves in 3 generations” is a saying found in nearly every language and culture and is a reality, not just a myth: only 20% of family businesses last beyond 60 years in the same family
• The biggest dilemmas facing business-owning families are family based (e.g., ill-prepared successor generation, family fragmentation as it grows, emotional conflicts hindering problem-solving and communication), more so than business based issues (e.g., changing market environment, tech obsolescence)
• The most enduring multi-generational family businesses 1) keep the business strong and healthy enough to be passed down AND 2) continue a healthy, happy family into the next generation — both herculean feats
• 3 stages of a family business’ evolution, each with its own key issues:

1. Entrepreneurial founder still in control or successor is a controlling owner
2. Succeeding sibling generation in charge
3. Cousins (often 3rd gen. or later) are in leadership

Five Insights

I. Successful family businesses aren’t just “lucky.” They earn their success through enormous effort and embracing the challenge: “We see the challenge of perpetuating a successful family business as one that strengthens us, an opportunity and not an intimidating problem.”

II. Issues within a family business — whether business or family related — are common and predictable, but accept that different people within the family will have different perspectives. Meaning, families can learn from others and aren’t alone in their issues!

• The most common and predictable issues include: succession; financing business growth vs. family liquidity; attracting, retaining, and rewarding non-family key managers; compensation (including family); and employment of family members

Roles in a family business system: Owner, Family Member, Business Manager

III. Good communication makes or breaks business families

• Good practices: regular family meetings, forums, round tables, or other systems to promote, facilitate, and assure ongoing sharing of information, ideas, opinions, attitudes, and feelings (which requires openness, trust, and vulnerability). These meetings do not revolve on the business as the topic of discussion, but rather where all family members have a chance to discuss how the business affects their lives (e.g., educate themselves, pursue hopes as a family, talk about purpose)
• Include independent board members: family businesses with independent board members grow faster and have more accountability. These boards can have family and non-family key employees on it, but also a minimum of 3 independent, non-family directors (typically CEOs of other companies, not suppliers, customers, consultants, friends or advisors for the business or family)

IV. Planning is essential for continuity

• Business strategy plan: where are we going as a business?
• Leadership and ownership succession plan: which family members will be in thee business? How many of them? What are their roles?
• Personal financial plan: is there a financially secure path for family owners (e.g., income producing real estate portfolio for all family shareholders)? Who provides capital to build the business vs. liquidity for the family or paying estate taxes? (*Book rec: Strategic Planning for the Family Business by Randel Carlock)
• Family continuity plan: core plan that holds all the interlocking factors. Family comes first. What do we want to accomplish together as a family? How do we get there? How does owning a business get us there?

V. Commitment is Required of Us

• Commitment to the family’s purpose, commitment to planning for the future, commitment to the valuable work that takes place in family meetings, commitment to the business and continuity within the family
• Exercise during family meeting: Make a list of all the disadvantages or difficulties of perpetuating the family business. What are the advantages or benefits? The disadvantages will likely be classic issues that all family businesses face, but the advantages can be inspiring and provide values, vision, motivation, and energy to accomplish something together

Four P’s (to Reduce Friction Between Family & Business Needs)

I. Establishing Policies before they are actually needed: preparation and communicating these policies — based on consensus help 1) give attention to issues before they become emotional and personal and 2) set expectations with fewer surprises

• Example policies: employment for joining and moving up the business, shareholder agreements for how to redeem shares and under what circumstances (e.g., company ROFR), mandatory retirement policy, compensation and performance appraisal policies

II. Sense of Purpose

• Compass for why family is doing this together? Why are we working so hard to make the business successful and committing to it long-term? Should give the energy to get through inevitable tough times. Enables family involvement in something larger and more significant than themselves

III. Process

• How does the family work together to problem-solve when inevitably unanticipated issues with no policy guidelines arise? What is the process for a family to make new policies?
• Ferragamo family meetings: when debating issues, each shareholder has the power to veto, no matter how many shares he owns (encourages equal participation and consensus building)

IV. Parenting: refer to the 50 Lessons below (organized by stage of business)

Ownership Stages of Development (and Types)

• Ownership and strategy is dependent on family size, country’s estate tax laws, industry environment (and business life cycle), business character / profitability (e.g., how capital intensive and profitable to accommodate family choices), and non-business assets (the more assets the family has out of the business, the more empowering it can be for individual autonomy)
• Different families will also have cultural assumptions or other interpersonal dynamics that influence the way families perceive their relationship with their business

Stage 1: Owner-Managed

• Proprietorship: business serves the pleasure of the owner and his/her family
• Capitalist: maximize shareholder value of the business — even if it results in a sale of the business
• Steward: preserve and enhance the business for future generations

Stage II: Sibling Partnership

• Co-Managing Partners: siblings share equally in ownership value, power, and managerial responsibility
• Caretaker: one sibling has ownership control, such as a trustee or “golden share” position (one share has all voting power), and takes personal responsibility for the business and the welfare of the family while all siblings participate in the rewards of ownership
• Investment Partnership: siblings are non-employed investors but a non-family executive or trustee leads the business

Stage III: Cousin Collaboration

• Family Holding Company: some family members collectively govern the business for the welfare of the family
• Entrepreneurial Venture Fund: family members are encouraged to start their own ventures with the use of collective family funds. Success in any venture is shared, in part, with the family, and, in part, to fund future family-member ventures
• If Public: Family owners can hold their publicly traded shares or divest as they wish. Governance and employment decisions have the same standards as non-family controlled, publicly traded companies

Stage I — Owner-Manager Lessons

1. Heads of family businesses, called “social entrepreneurs,” seek continuous improvement to build a multi-generational institution

• To be enduring, family business CEOs must now be able to lead their organization through 2 to 4 waves of strategic renewals in a 20–30 year period. They need to create several strategic initiatives over time to combat the faster-pace, changing, more competitive landscape

2. Successful family businesses eventually figure out the value of having a mandatory fixed retirement age or date applied evenly to everyone in the company, especially to the family (e.g., retire from the company at the age of 65 and from the board at 70, ownership also transferred by a certain date)

• Such a policy 1) creates accountability to live up to the commitment; 2) presents growth opportunities for other people in the organization, family or not (e.g., can help motivate younger siblings) and 2) catalyzes succession planning years earlier to prepare the next leaders and present them to the board
• The senior generation transfers responsibility of the CEO day-to-day job, authority (complete control over decisions), and ownership control to the next generation

3. Voluntary accountability: e.g., deciding to include independent board members to raise the professionalism and accountability of the management team (board can also be a wonderful resource for strategic planning, approving financial plans vs. budget)

4. Operating on the principle of merit: competence and earned privilege trump nepotism. This works in the interests of the business and family long-term. To a child not ready to take a promotion, “Because we love you, we feel it’s important to earn your privilege. Otherwise, you’re not going to know who you are and have the self-esteem you deserve.” At a young age, children are conditioned to believing in merit and understand what is clearly expected of them if they wish to join and rise in the business. Family members are not promoted beyond their ability to succeed

5. Attracting the most competent family members: to be a long-lasting, successful business, how do you make your business attractive to the most promising next-generation family members?

• It’s worthy to give young children basic experiences that ignite their enthusiasm about the company (e.g., research projects, drafting a report, visit a customer or competitor, attend a tradeshow)
• As they become young adults, compensation becomes increasingly important and must be thought thoroughly
• Don’t shy away from letting go incompetent family members who don’t meet the bar

6. A strong family firm not only needs competent family members in the business but also a cadre of seasoned non-family managers to bring fresh thinking and challenge the thinking of the organization

• Hiring and developing non-family talent is a key to success. Some families have guidelines on family vs. non-family composition (e.g., at most 1/3 family in top positions, 1/3 non-family internal promotions, and 1/3 experienced external execs). “We want opportunities for non-family to run profit centers…that there’s a good career for them here, an opportunity to attain a high level of responsibility.”
• To save room for talented outsiders, an employment policy that raises the bar even higher for family members to join may be necessary

7. To attract and retain excellent non-family managers (and vie with other companies for the same talent pool), family businesses need to pay well (income is competitive) and provide opportunities to generate wealth — nest eggs at the end of one’s career

• Generally, family businesses do not want to distribute shares to outsiders to minimize dilution of family ownership and control. Other methods include offering: 1) “pot of gold” ($X bonus after 10 years) after a designated number of years; 2) a lifetime annuity for executives who stay until 62; 3) long-term bonuses linked to performance; 4) phantom stock (without rights of ownership); 5) equity in another family-owned investment (such as real estate or a side venture)

8. Family is more important than the business. In the most successful family businesses, even when the business is incredibly intense, parents find a way to disconnect. When with family, they focus on the family — setting aside time to enjoy activities and have fun. Without a “family first” mentality, fragmentation begins occur when the next generation resists working long hours (“lazy” vs. “balanced life”).

9. Family business skills are not innate but acquired through active studying, learning, thinking, and reflecting. Some families bring in outside experts to speak at family meetings, or send some members to visit other family businesses to come back and share insights

10. Wealth doesn’t have to be flashy. Savings and prudence in spending are practiced. Children raised under an understated wealth attitude tend to better owners and workers

11. Wealth is neutral — not an evil to fear, avoid, or be enthralled with: it’s important for the senior generation to not deny the wealth but to show that wealth is merely a result of effort and good fortune. “We’re very fortunate and can afford it. Yes, we work harder. We’ve accomplished a lot, and, as a result, our life is enhanced and easier.” Practice the old adage: “To whom much is given, much is expected.”

Stage II— Sibling Partnership Lessons

• Most critical issue at Stage II is the capacity for siblings to work together as a team. A weak business with a strong sibling team has more promise than a strong business with a fractured sibling team. Collectivism and mutual dependence — the willingness to share sensitive, personal information (e.g., salaries, estate plans, and investments) — are more valuable than individualism that defined Stage I’s entrepreneur founder
• At the Sibling Partnership stage, despite siblings’ difference in personalities and abilities, it works best when things are kept as equal as possible in terms of individual standards of living and perceptions of people’s importance in the business (e.g., if one sister is financially less well-off, the rest of the siblings should be mindful of rectifying the sizable difference because one day her children will be owners, in preparation for the cousin stage. Methods of lifting her standard of living through a dividend policy or buy back some of her shares)

12. Most G1 of families discourage redemptions so that money is available for company growth or ostracize family for doing so. Ironically, the more freedom of exit is available, the less family members will fight it or even exercise it.

• Far-sighted families make it easy for Stage II siblings to sell their shares (called “graceful pruning” or “facilitated pruning”) because: 1) in the long run, having fewer owners is easier to manage than many owners; 2) at some point, some family members are going to want to sell their shares, and preventing them from doing so creates disgruntled shareholders (increasing the possibility of litigation and unpleasant publicity); and 3) assuming the company continues to grow, buying out their shares today is cheaper than in the future when value per share has increased
• “A family business isn’t for everybody. If you ever want to exit, we have mechanisms in place to make that possible. Taking advantage of them is okay and has nothing to do with your membership in the family”
• Perceptive families don’t price the stock so cheaply that an unhappy owner can’t afford to sell: instead, they may pay 10–20% premium to make it attractive for an individual to exit
• Every family business needs a good exit clause in both its buy-sell agreement and its valuation and liquidity policy. More important, a good attitude about exits — generous and non-judgmental. Ultimate goal is to concentrate ownership in the hands of people who share the same interests and values to move the company forward

13. Successful family businesses are very wise at using their unique advantages as a privately held business. Advantages include long-term orientation (no quarterly shareholder expectations), ability to move quickly if the CEO enjoys the trust and support or her siblings.

• Trust is a strength in family businesses: Ayala family has an unwritten rule, “Family shareholders do not invest in companies competitive to Ayala.”

14. Long-lasting businesses give back to their communities and invest in social capital / social responsibility (e.g., schools, hospitals, earning the trust of their thousands of employees, donations to municipal projects)

• This protects and sustains them through external changes, such as government or policy changes. A positive reputation also comes back to them in terms of being able to attract employees and customers

15. The best family business operators make decisions that are favorable to the business’ vitality, strength, and longevity.

• This “business bias” comes from the notion that what is good for the business also serves the interests of the family, particularly on policies where family and business intersect (e.g., employment, compensation, valuation, liquidity), or even when deadlocks arise in decision-making (e.g., purposefully putting decisions in unbiased non-family managers or independent board members to break the tie)
• Bahrain’s Kanoo Group: “if there is a conflict of interest, then the company must come first.”
• For a “business-first bias” to work, it has to be well-explained to the family, down through the decades and generations, that professionalism in business is a positive value for the family, one that serves the family’s long-run interests best

16. Family employment is selective and a balancing act. On one hand, it’s better to have a higher standard of entry for family members to encourage only competent family members to join the business and assure there is an upward trajectory for able, non-family. On the other hand, the policies can’t be too discouraging, because if there are no family members in management, the business will likely cease being a family business

• If the family is growing in size, they may institute rules, such as no in-laws in the business, permit only one person per couple, discourage part-time jobs
• “Because we have the privilege of owning a business, we have the burden of having to deal with the public’s expectations and employees’ expectations of family members
• Ayala: “We are always tightening the rules for a family member’s right to be involved. What are the professional skills needed? Does the family have a proven track record?”

17. Contrary to the Owner-Manager stage’s entrepreneurial privacy / protectiveness over company information, such secrecy is harmful to Stage II Sibling Partnerships. Owners of successful family businesses demonstrate open disclosure in 3 main areas:

• Compensation, perks, and benefits: salary, trips, support for a new home
• Outside investment opportunities (in the event the investment affects the business): open discussion and inviting siblings to co-invest if they’d like prevent questions from siblings like, “Why weren’t you spending all your time running our company?” “You mean you heard this terrific opportunity and didn’t tell the rest of us? As CEO, you’re supposed to represent all of us.”Or if the investment goes sour and finds himself in a financial crunch, his siblings will know that the dividends will be important and plan accordingly
• Personal estate plans: settling an estate with planning and clarity can spare the next-generation the years required to sort out (trusts to distribute dividends, hold voting power, and ownership of family shares), ensure a smoother transition to the cousin stage, and mitigate the uncertainty around death taxes
• Open disclosure goes beyond just the siblings who work in the business: siblings not in the business should receive information through shareholder or family meetings

18. Aggressive giving: the best and cheapest way to avoid the death-tax crisis in many countries is to give away as much ownership in stock as possible as early as you can to future generations. The less you hold in your own name and the less amount of time you hold it, the lower the tax will be. With the help of a good tax advisor, consider your countries’ annual tax-free giving limit, exemptions usually taken at time of death, and compare gift vs. death taxes

19. Instilling an appreciation for the business — from an early age. Education with age-appropriate activities and even paid involvement in the teenage years help develop a sense of pride in a company they may have ownership in someday. Educating them is different from pressuring them to join the company

20. A family code, or (interpersonal) code of conduct, should be created in Stage II, if not already established in Stage I to state how family members will treat one another and how they will conduct themselves outside the family. Examples include:

• “Family meetings start and end at the same time.” “We respect each other.” “We will be prepared.” “I won’t interrupt.” “If the situation gets too intense, I have the right to call a time-out.”
• Code should address how family will work together; handle communications, disagreements, PR / public exposure; what the decision-making process is; provisions for sharing estate plans with siblings and children
• Family should work together to agree upon a constructive, productive code

Sample Family Code

21. Communication skills: successful business families invest a great amount of time learning communication skills. The #1 topic for family meetings with an educational focus is effective listening skills. Other families work on presenting, confrontational, meeting management and facilitation skills. Many refresh their communications training — including children and in-laws — every 3 years

22. An unusual lesson is the value of ensuring members playing essential roles in the family or the business have a sense of financial independence and security, their own financial nest egg to manage themselves, not accountable to anyone. Applies to:

• Spouses (wives): a nest egg for a spouse, particularly a non-working one, reduces the culture of control and enhances a democratic culture. Also helps spouses have their own individuality / dignity and frees them from being dependent on a paternalistic senior generation. Sets an example for the next generation
• Next-generation business leaders: successor-leaders who have a nest egg, even if they’re not having doubts about staying in the family business, are better leaders because they feel more secure about themselves and their judgment
• Family members who are shareholders but not involved in the business: for them to have nest eggs may be controversial, because Stage I founders often think, “nobody deserves any money unless they have earned it.” However, family shareholders with independent financial security can voluntarily support decisions that strengthen the business rather than selfishly acting out of fear for their own well-being. Encouraging financial responsibility at a young age is desirable, but these savings are too slow than more sizable nest eggs to liberate / empower owners.
• Nest eggs can either come from the business via special dividends or distributions (at the cost of reinvesting in growth of the business) or from the senior generation (gifting cash instead of stock, which would save on death taxes at transition)

23. Strong sibling teams recognize that there is a trust-building element to openly sharing investment opportunities with each other. Reflects the generous spirit, “wouldn’t it be nice if all of us were better off, if we could all be more liquid, diversified, successful? The more the differences in standards of living are apparent, the more difficult to hold the sibling team together

• Doesn’t mean every member needs to invest and participate if they don’t want to: some siblings may step it up and invest with their own money on behalf of a sibling that doesn’t participate, knowing it’s better for the family in the long-run

24. Educate in-laws as they enter the family: often, there is a mentor, a family elder or family leader who introduces in-laws to good family advisors and be educated to learn about the family business, family foundations, or family offices

• 3 areas where in-laws can use your help: 1) understanding family’s culture (history, traditions, ways of thinking); 2) nature of the business (financial statements, BoD members, estate planning, dividend policy, shareholder agreement and how to liquidate); 3) indoctrination into family’s process (may be asked to participate in family meetings or trainings like on communications)

25. Passing on a value system: business ownership provides an opportunity to pass on family values that can be tested and proven in the real-world business (e.g., integrity, persistence, openness, respect, trust with customers / suppliers, belief in the entrepreneurial spirit)

• “What are our values?” Outside-in exercise to discover: Can interview non-family who know the family and the business (e.g., employees, community) how they perceive the family’s values to be
• Can also have each family member during a family meeting to share a meaningful personal story or memory and explain what the moral or message of the story is

26. Successor to “Mom,” or a family leader is important: this leader tries to keep communication open; provide moral cohesion; serve as a mediator; nurture people; make sure everyone is treated fairly; reinforce values; educate younger members about the business

• A bunch of sticks is stronger than a single one. Fiefdoms among branches of family are damaging. Successful sibling teams choose to co-own rather than just co-exist

Stage III — Cousin Collaboration Lessons

• Whereas siblings rely on collectivism and mutual dependence, cousins rely on voluntary association — commitment to the business is freely chosen. In this stage, cousins need to believe the business has a social purpose or a special family meaning, intangible value, to justify holding the stock, learning about the business, nd traveling for shareholder meetings

27. Changes to the entity, culture, values are accepted and inevitable. The evolving entity is flexible, both on the business and family sides

28. Families do not lock themselves into the original business Grandpa started, but are in the “business of doing business” (e.g., business will change through M&A, divestitures, even closing the original business as the Marriotts did closing their original food services operations to focus on lodging & hotels)

• This spirit of enterprise promotes the idea that families can be purposeful and work together to drive great accomplishments (e.g., create good places to work, contribute to society, provide family members good life experiences and challenging professional opportunities)

29. As both the family and business get older and larger, new sources of capital may be necessary to satisfy estate planning, invest in the business / start new ventures, buyout family members (depending on the capex)

• Options to raise capital include: going public parent co, borrowing, taking on equity or JV partners, selling a business, holding minority shares in other companies, spinning off strategic business units, IPO subsidiaries

30. Dividends are flexible, should reflect the business’ ability to pay and be tied to profits (e.g., 20% of profit policy with a minimum dividend of $50K for every shareholder). If there is a set formula, shareholders understand that dividends are a function of the company’s success and creates a source of management discipline

31. Positioning the company for the long, long term (infinite time horizon) to sustain its brand and reputation for future generations.

• Hermes started as producer of custom-made saddles and by the 5th generation attitude on stewardship: “if it increases the inherent survivability, longevity, continuity, and strength of the business 15 years from now, it’s a good thing to do.”

32. Family members are free to redeem shares, but they understand there is a policy in place to establish a fair price that applies to all

• Some families set the share price once a year and forbid selling shares to outsiders (a holding company is set up to buy back family shares; family has the right of first refusal, or Class B voting shares that can be converted into Class A at a less-valuable ratio)
• Others turn to the public market to resolve the redemption issue

33. Families view the business as owned by the entire family and even future family, rather than owned by distinct members. This kind of “impersonal ownership” helps the business focus on building LT value

• What’s best for the family or for the business?” instead of”what’s in it for me?”
• Some families practice this kind of impersonal ownership by putting their shares in 100-year dynasty trusts or offshore trusts. Downside of this is the business might lack discipline or isn’t run with professionalism, good leadership and oversight (good board)

34. Family meetings (distinct from management or shareholder meetings) are focused on the interests of the family. Purpose is to instill feeling of community, cohesion, and family purpose

• For larger families, often run by elected family council to organize bonding activities, articulate mission and meaning of family, educate and develop youngling, acculturate in-laws, discuss family welfare and philanthropy, bring in outside speakers

35. Family members explore and discuss what responsible ownership looks like. What does good stewardship mean?

• Some families have a protocol or even a pledge or covenant that they agree is a philosophy of what good ownership means
• Example pledges include: treating each other with respect; being open and honest in interactions with one another; putting welfare of the company first and the family ahead of own; speak with one voice; continue education to perform duties to best ability; work to earn the trust of other owners; strive for financial independence to not harm the business out of personal need; respect role of management and board; prepare next generation for responsible, effective ownership

36. Owners remain active, involved (even if not working in the business), and committed to the business. They care about the values and stay vigilant so that good managers know the owners are paying attention. Being active means:

1) Being knowledgeable and supportive of the business strategy, and if something is wrong, taking corrective action through the board

2) Serving as a cultural ambassador, representing the values of the family, to set an example for the business

3) Practicing good and educated governance by electing board officers that determine values, visions, and goals guided by management and the board

37. Nose in but fingers out: families understand where ownership starts and stops and expressing any opinions through proper channels (speaking first to the owner's’ representation on the board). Family owners are informed and involved but they don’t meddle (managers are focused on making profits and there is a department to resolve shareholders’ problems)

38. Family members respect their experienced executive managers and their management abilities

39. Family members stay educated on 3 major areas:

1) Interpersonal skills: working together, how effective meetings are run, consensus building, how a good committee chairman should act

2) Personal development: motivational and inspirational speakers, preparing young people for college and their first job

3) Family culture: family tree, creating a family council — a council of elders or subset of the family that look after the welfare of individual family members and act as mentors or coaches

40. Family member development resources and programs: career counseling, vocational aptitude testing, coaching for young people considering joining the family business

41. Having a family leader, distinct from business leader: Even family leaders need a succession plan.The family leadership role can be voluntarily played by anyone who can bring cohesion and care to a large, complex organization

• “We value the person who leads the family as much as we value the person who leads the business.”

42. Provide for family members “in need”: maintaining a pool of cash to help individual family members, overseen by the family’s council

43. Family councils can have 3–4 or more committees or task forces: including committee on family education, a task force that looks at how to prepare family members for board participation, reunion planning committee (and determining what information from the business should be shared), committee that plans family meetings, family philanthropy committee, next generation & succession planning task force

44. Family philanthropy as a fundamental part of the family’s value system and family identity

45. One family concept: branch representation and family rivalry isn’t good for the family or business; decisions are based on one vote per person, resulting in a spirit of selecting people from the family who will best serve the welfare of the entire family

• Families that fracture in one generation tend to perpetuate fracturing in future generations: if a parent can’t learn to work with a sibling, how can his own children work together?

46. Family mission statements are critical, especially to smooth over difficult situations that occur and define the relationship of the family to the business

47. Family values should be reinforced, propagated, and communicated both within the family and in the business (in transacting with customers, vendors, community and employees)

48. Social purpose: making money is important as a resource and provides a measure of performance, discipline, competitiveness, and competence but the deepest purpose is to do good for people

• Ayala: “catalyst for the infrastructure needs of the country…giving people the quality of life they deserve…clean running water and efficient transport”

49. Family members going through the process is more important than the end results. Working struggling, and learning together to develop policies and set goals and values

50. Family members become public advocates with the lessons they have learned…sharing with other families, renewing their own beliefs as a way of practicing public accountability