September 28, 2008

Are Your Children Ready To Run the Family Business?

By Perry, Phillip M

"Lack of sufficient planning is the major contributor to the failure of family businesses." When you retire, will your business prosper under your children's management?

Maybe not. Only one of three family businesses survives transition to the second generation, according to Boston-based Family Firm Institute.

Business owners commonly make a number of fatal mistakes when attempting to pass the entrepreneurial torch. What are they? Twelve leading family business consultants cite the most common errors to avoid.

Mistake #1


"Family business owners have an enormous tendency to avoid the whole issue of succession planning," said Paul I. Karofsky, executive director of the Northeastern University Center for Family Business, Dedham, Mass. "Lack of sufficient planning is the major contributor to the failure of family businesses."

Start by determining the desires of both generations. "The senior generation must address its personal, career and financial plan," said Karofsky. "If the parents are unclear as to what they want to do with their lives beyond running the business, then they will be reluctant to plan further."

And don't take anything for granted concerning the desires of the second generation, he added. You may think that your son or daughter wants to run the company, but that may not be the case. Often the children of a business owner will claim to want control only to avoid conflict with, or avoid hurting, the parents. The consequences can be severe: Without adequate motivation the second generation can destroy the business.

Mistake #2


Your family needs a shared mission statement. What are your values? What are you out to accomplish? The second generation will feel alienated if they are left out of the process for answering these questions.

Once you develop a shared mission statement, you can move on to deciding what kind of management is needed to get the business where you want to go. The process of long-range planning will illuminate certain needs of the business so that the natural successor- among rival siblings- will become apparent to everyone.

Developing a strategic plan does more than just show how the business will be around for the long haul. It also indicates what values will carry the field when family and business decisions conflict.

Mistake #3


The second generation often starts very young at the office, doing mundane tasks such as stuffing envelopes or answering the telephone. And although the task level of their work may increase as years pass, the management expertise required often does not.

Parents often think that the children are learning something by osmosis about the business. They don't think about what is appropriate from the standpoint of management expertise. Consequently, the next generation may think they know the business, but they only see it from a worker's perspective. They have learned how to run the ship from inside the hull, never turning the wheel.

Solution? Train the second generation in management procedures, not just workplace mechanics. What do the customers want? What is the banking relationship? How does the business work with suppliers? What relationships do you want with employees? And just how does the business make money?

Mistake #4


Sibling rivalry can lead to business failure. Yet spotting the root causes of such quarrels can be as difficult as dousing the flames. Families will often deny the problem exists.

"It may seem that two adult children have surface conflicts, but their problems have deep childhood roots," explained Joyce P. Brockhaus, Ph.D., principal of The Brockhaus Group in St. Louis. Perhaps an older sister worked hard at the family business but is supplanted in a management position by a younger brother whom she took care of as a baby. An adopted child may cause resentments. Or one son may opt out of a family business only to achieve a higher degree of management skills elsewhere. When he returns to the fold, he supplants a brother who was expecting to take over the business.

Disruptive resentments result from all of the above. "From a psychological point of view, a lot of emotional energy goes into keeping the water calm when there is great turmoil underneath," said Brockhaus. "The effort at maintaining peace drains productive energy from things that need to be done to make the business succeed."

The solution is to deal with these inner resentments, talk them out and keep them from scuttling the future of the family.

Mistake #5


Very often the personalities of founders don't lend themselves to team management. They've gotten where they are through the years because they are very individualistic. Today, though, a changing marketplace demands versatility and a variety of ideas. It requires a highly functioning management team rather than the old reliance on a single leader. Failing to adjust to this sea of change is dangerous. Many family businesses fail because the company cannot survive the transition of management styles.

The second generation must be given time and encouragement to develop their own management styles. "Many successors have a dilemma," said Joe Paul, a family business consultant in Portland, Ore. "They either fall into being a clone of their parents because of all of the expectations of the people in the system, or else they rebel against being a clone and focus too much on being different from their parents. Winning a contest over authority becomes more important than succeeding in business."

Solution: To build management skills, parcel out sections of the business to second generation members. Evaluate their work as carefully as you do non-family members. In what areas do they need to improve prior to taking the reins of the business?

Mistake #6


It's often smart to bring in an outsider for a stipulated period of time to professionalize the management structure. This individual can help the successors develop their personal and professional plans and groom the potential successors for positions suitable for their skills. Be careful, though. The interim manager must be given sufficient authority and must be in a position to hire and fire family members. Parents often try to resolve family issues through the workplace. They need someone there who makes decisions based on the best interests of the business.

One more thing: An interim manager needs to know that the position is temporary, ending when the second generation is ready to take over.

Mistake #7


A business can be weakened when it ignores the needs of managers who are not family members.

Unless the family is very big, outsiders will comprise the management team. How do you keep and reward them? Many times, managers are in their 60s and are very anxious about the future of the business. The first rule is to get them involved in the process.

Second, since you are going to develop a son or daughter for the top management position, develop important roles for the non-family managers. They need to know that even though they may never be president of the company, they will be rewarded with good positions. They need both short- and long-term incentive plans. Examples are stock ownership or deferred compensation plans.

"Be real clear with employees and with family members that it is a family business and will be passed to a family member. So no one comes in to the business expecting that a non-family member will have a chance," said Susan Lazar, president of Susan Lazar Consulting in Minneapolis, Minn. "It's important for people to know what the possibilities are."

With the benefits of ownership come responsibilities. "Try to have family members understand that they are under a microscope and non-family members will scrutinize them," advised Lazar. "Do they not come in on time or do they get extra days off? That sets a bad tone. I've worked with families where people trumpet their perks around. Be discreet and work hard. Don't try to slide by."

Mistake #8


Emphasizing involvement in the decision-making process is good, but how do you do it? You need a vehicle for decision-making that goes beyond the seatof-the-pants style characteristic of the one- person show. The answer for a growing number of family businesses is the family council. This is a group of family members responsible for meeting regularly to discuss the direction of the firm and to handle key questions.

Sounds a lot like a board of directors, right? It's very close, but different.

A family council is better than a board of directors, because it can see decisions from the point of view of the family, whereas a traditional board might look at the business alone. The latter approach can be unrealistic, since decisions based only on the bottom line can alienate family members. Success comes not from denying the family involvement in a business, but rather from dealing with the resulting problems in a rational manner.

The council deals with questions such as: What requirements will be placed on family members who want to be active as employees? What education will they be required to have? What compensation will be given to active and inactive family members? The board of directors- with a majority of outsiders-must still meet to decide business issues. The family council is in addition to a board of directors, not a replacement.

And how do you deal with conflicts between these two bodies? There should be family members on the board and active in the family council. They should serve as emissaries between the two groups.

Mistake #9


When the business is finally transferred to the second generation, what will happen financially? Do the new owners and managers fatten the bottom line? Or do things go downhill fast, with the business finally dwindling down to nothing?

The second possibility is all too common. The result is a loss of income for the senior generation, which may be counting on continued success of the company for their retirement years.

Consultants suggest putting into place performance goals, or hurdles, which the new generation must meet once they have taken over the business. Such hurdles can include profitability, return on investment, sales increases, cash flow or other financial ratios. If the new management does not meet those goals, the bylaws may call for the company to revert to the control of the senior generation or to be sold to a third party.

"These hurdles can be excellent tools," noted Aron Pervin, president of Pervin & Co., a family advisory in Toronto, Canada. "But they are primarily useful as mechanisms to lay down ground rules. In my experience, if the hurdles are not met, there is never any retribution."

So although Pervin recommends that hurdles be set, he suggests another vehicle for ensuring the financial well-being of the seniors: "I advise obtaining enough money either through debt or equity to put in the parents' account so if the business fails they will have enough to last until they die. Now the kids don't have to worry that bad business decisions will devastate their parents."

Mistake #10


Transferring all of the assets at one time to the second generation can create an estate tax burden so great as to threaten the future of the business.

Frequently businesses are worth a significant amount of money even if the owner doesn't think so. The business caught in an individual's estate could be subject to a 60 percent tax. How do you raise the money? Start early to activate a transition plan for the assets of the business. Get insight from your accountant on the many vehicles available, including lifetime giving plans, limited partnerships, trusts and preferred stock offerings.

Mistake #11


In an attempt to placate non-management family members, family businesses often transfer small units of stock on a regular basis, without conveying responsibility of ownership. That causes problems years later, when non-management family members want more dividends distributed. Draining cash from the business can inhibit growth.

Passive family members can cause quite a problem for businesses. A common mistake is to create a strategic plan for the business from the standpoint of profitability-divorced from the desires of the passive family members. The result is that some individuals will feel they were treated unfairly.

To avoid this, plan three areas concurrently: the strategic direction of the business, the transfer of the estate to family members and the succession of management responsibilities. It's hard to handle these three areas in a linear way. You can't address one without addressing the other two. You have to have all three activities going on at the same time. This can be done by scheduling a series of meetings that rotate around the three concerns, treating the questions of each one in its turn, then adjusting the answers to accommodate the decisions reached on the other two.

For example, in the area of estate planning, you may decide that you want to distribute dividends to passive family members. This decision will affect your decision-making in the strategic planning area. If you must distribute dividends liberally, then you must cut back on growth in market share, or find some other source of funding to do the same.

Mistake #12


"Family business transition is a process which takes years and years to undergo," cautioned consultant Brockhaus. "It doesn't just happen overnight. And if you think it can happen in three months you are mistaken. Some people say it takes 10 years to train everyone to the level required for business success."

Most people don't bother. They are excited about running the business and don't think about succession planning until the second generation is ready to take over. You can do better. Follow the tips in this article to stimulate your planning efforts. Take an early initiative to ensure that your family business survives and thrives.

Paul Karofsky, Northeastern University Center for Family Business

Phillip Perry is a freelance writer. He can be reached at [email protected]

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