Management and Legal Challenges in Planning A Family Business

The management and operation of a family business raises legal and strategic challenges that traditional businesses rarely face, primarily because love and business often don’t mix. For example, how do you handle the firing of a key employee who has become obsolete or unproductive when that person is your son, daughter or nephew? How do a husband and wife effectively manage a business they co-founded when their marriage is falling apart? How should ownership be separated from control when a founder is ready to step down and his two heirs are completely uninterested in running the family business?

Some of these issues are day-to-day challenges, and some are part of a long-term strategic process known as transition and succession planning. The dynamic of succession planning in a family business (which I will cover in depth in a subsequent article) is complex because each family member may feel that he or she has a vested interest in the company’s future. Each may have spent after-school hours working in the business or may have had special events missed because of the demands of the company. Most would like some participation or involvement in the business, even if not full time. Each may envision a different type of participation that may or may not be feasible depending upon performance or future needs of the business. For example, if two of your three children move away to pursue lives and careers outside of the company, yet fully expect to have a one-third ownership interest when you step down, will the remaining one-third interest be enough incentive for the child who stayed home to take over the business? What is fair? To what degree are the two children who left penalized for moving on?

Seeking Answers 

There are no easy answers to these questions. The challenge, then, is to select the child, children, or other relatives who will ensure the continuation of the business as a family enterprise, provide participating roles for the remainder of the family, and accomplish all of this while maintaining family harmony. These issues should be addressed in the preparation of the Family Business Continuity Plan, (to be covered in depth in the subsequent article.) The key objectives of the Plan are to provide smooth and seamless transition of the ownership and control of the business, provide liquidity for the retiring generation, minimize estate taxes, preserve capital in the company for future growth, and, wherever possible, maintain family harmony.

However, these problems occur in the day-to-day management of the family business as well. The leader or founder often must separate issues of ownership and wealth from issues of management and control when developing a business. In fact, the founder must consider the current business from multiple perspectives: sons and daughters who enter the business, siblings who do not enter the business, the spouses of the founder’s children and the founder’s employees. For each of these four groups, there are issues of career and financial planning, career opportunity and career satisfaction, fairness of treatment by the founder, family relations and old-fashioned politics and greed.

The issues surrounding the delegation and allocation of responsibilities for managing and operating the family business are complex and challenging. Often, they are complicated by, among other concerns, deep-seated psychological problems, sibling jealousy and rivalry, and marital problems among the children and/or in-laws who don’t get along. Thus, family business owners and operators must view their roles, not so much as a gift or entitlement, but rather as a responsibility to the founders as well as to future generations. The family-wide preservation of wealth is in the continuity of the business, not in its demise due to infighting. Family business owners spanning multiple generations must be prepared to accept the decisions made by their parents and the advice of their parents’ professional advisors. The transition of the ownership of the business can be implemented without conflict and emotional pain if all business heirs remain flexible and respectful of the parents’ decisions.

The mix of management, financial, family and psychological factors that affect the selection of current and future leadership triggers the need for expertise beyond that occurring in the typical family business. The next generation would be helped greatly by a diverse external advisory committee, as well as individual consultants, that all play a role in the preparation of the Family Business Continuity Plan.

Setting the Stage for Solutions

The management plan and structure in a family business can neither be too rigid to ignore the fact that circumstances can and will change, nor be left for the last minute with the business being turned over on a whim to whichever relative was standing closest to Uncle Fred when he died. There are several key steps that can be taken today to assure effective operations and save management structures for the present, as well as set the stage for a smooth transition in the future. These steps recognize that any successful transition is, by definition, a process and not an event. Therefore, now is the time to begin that process by implementing the following:

  • Prepare an Organization Chart With Defined Position Descriptions. Determine now which family members (and non-family members) will hold which positions, with clear statements of duties and responsibilities, as well as the performance goals to which they will be held accountable. In assigning positions, be guided by merit, education and commitment, not by love or nepotism.
  • Train, Train, Train. Set up a system for training, coaching and formal mentoring so that the current generation of leadership can begin to impart knowledge, experience and trade secrets to the next targeted generation of leadership. The training should not be ad hoc, but should be structured as a mix of formal classroom training, field experience and informal training at social or family events. Start now before you are unable due to death or disability. Start now before you lose the next generation of leadership to a competing company, career or other life circumstance. Start now so that key lessons can be repeated and reinforced, not all dumped at once a month prior to your retirement. Start now so that you will be able to enjoy your retirement without six phone calls a day from your son or niece!
  • Get Good Advice. One of the keys to peaceful current management structures, as well as an eventual smooth transition, will be driven by the quality of the advice and input that you will get from your professional advisors, such as your accountants and attorneys, who should be experienced with the succession planning and transition management needs of closely held and family-owned businesses. You will also need an objective and experienced Board of Advisors, made up of outside business leaders and professional advisors who can help the company with difficult transition management decisions, as well as with the implementation of the transition management plan.
  • Establish Governance and Communication Structures. Many well-run family businesses anticipate succession issues well in advance and create a culture of genuine interest and involvement early on by creating a “Family Council” or even a “Family Assembly” depending on the size of the family. These non-traditional governance and communications groups may have certain protocols or by-laws (or even a constitution), which leave key decisions to be discussed and even voted upon by affected family members in a manner which augments and supersedes the traditional decision-making structure set forth in typical state corporate laws. These group-developed core principles will assist in the selection of the next generation of leadership. For example, once the vision for the family business is articulated, the Family Council then has a better idea of the types of future leaders it needs to begin to develop today.
  • Establish Criteria to Eliminate Surprises. The current generation of leadership should establish criteria for ownership and management candidates in the upcoming generation in order to remove the element of surprise when the successors are selected. The criteria must be clearly communicated to all involved. While it should be objective — noting education, performance and experience – it could also include some subjective standards and factors, such as passion, commitment, respect and trust by family members and employees. Establishing these criteria and then sticking to them will not only virtually eliminate the element of surprise, but also mitigate the risk of anger, dissent or even litigation.
  • Communicate Early and Communicate Often. The current generation of leadership must constantly communicate with the next generation, sharing information and imparting knowledge, not only to build trust, but also to take the pulse of the goals, circumstances and general mood of the next generation of family business leaders. The communication channels should be established and kept open through periodic reports, quarterly meetings, one-on-one mentoring and other forums to keep the next generation interested in the family business and poised for transition. These channels will help ensure that the proverbial baton is not dropped on the track during the handoff to the next generation.
  • Support (and Even Encourage) Employment Outside the Family Business First. The traditional approach of grooming the next generation has been to force them, starting as teenagers, to work their way up the ladder and eventually retire as family business employees. This is in many ways a dead paradigm. The more enlightened approach is to support and encourage a career track that includes employment outside the family business, which may be within or outside the family business’s underlying industry, with the hope and expectation that these designated leaders will return to the family business to take the helm at the appropriate time. The obvious risk is that they will not want to leave their current situation or profession, and that the selected heir apparent then refuses to make the transition. Notwithstanding the risk, most agree and advocate the broader experience that working outside the family business will foster will develop more confident and balanced leaders who have proven that they can succeed in other circumstances without the shadows of nepotism. This also allows for a more gradual phasing of the transition of the management and leadership of the business because the next generation isn’t just sitting around waiting for the present generation to step down, but rather gaining experience (and making the mistakes) elsewhere until the time is right. Naturally, the next generation should not be invited to return only days before the baton is passed; a minimum of a several-year pre-transition training and phase-in period prior to the passing of the baton should be built into the plan.

In summary, the current generation of leadership will not get very far if members of the next generation views their future in the business as some type of deep-seated moral and family obligation as opposed to a viable business opportunity. When current management responsibilities and the need to set the stage for an eventual transaction are presented as a duty rather than as a potentially lucrative economic and career opportunity, the results are likely to be disappointing. An organizational culture should be built around principles of stewardship, instilling the notion that the upcoming generation should regard themselves as guardians of a family legacy and that the ability to step into the shoes of leadership is a privilege to be earned and not a birthright.

More like this: Legal, Entrepreneurial Life, Talent and HR, Planning and Strategy

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