Keeping It One Big, Happy Family Business
by Tina Manzer
Only 30 percent of family-owned businesses survive the transition from first- to second-generation ownership, according to researchers at Baylor University’s Institute for Family Business. Only half of those make it to the third generation. The problem, experts say, is in the planning. Like any other exit strategy, selling to a family member requires a detailed succession plan, even though you may have known for years who will succeed you. Selling to a son, daughter or other relative does not mean you can take a planning shortcut.
But as many experts point out, keeping it “in the family” is very much worth the effort. A study released a few months ago by Oregon State University revealed that companies that promote themselves as family businesses garner more customers than their nonfamily competitors. Researchers Clay Dibrell, Justin Craig and Peter S. Davis support the idea that “family” adds value to a brand, gives companies a competitive advantage and contributes to positive financial performance.
Their study used a sample of closely held small and medium-sized businesses, defined as having fewer than 500 employees. “Lacking the substantive economies of scale and scope available to their larger brethren, small and medium-sized family businesses may be especially inclined to leverage their distinctive family name to create a form of reputational capital or family brand equity that helps enhance performance.
“Family brand identification is considered to be of the utmost importance for the success of entrepreneurial and small and medium-sized companies,” said the study’s results, published in the Journal of Small Business Management. “Family brand identity can be regarded as a rare, valuable, imperfectly imitable, nonsubstitutable resource.”
It helps large companies, too. BusinessWeek announced in 2003 that family-owned companies on the Standard & Poor’s 500, are “beating the pants off their nonfamily-run rivals.” At that time, one-third of the S & P 500 had founders or their families still on the scene, in most cases as directors or senior managers. BusinessWeek had tracked the performance of these companies for 10 years, and noted that, “the annual shareholder return averaged 15.6 percent, compared with 11.2 percent for nonfamily companies. Return on assets averaged 5.4 percent per year for the family group, versus 4.1 percent for nonfamily companies.”
In addition, the family companies trumped the others on annual revenue growth, 23.4 percent to 10.8 percent, and income growth 21.1 percent to 12.6 percent.
So, if you own a family business and are thinking about retirement or your next career, it’s obviously good business to keep it a family business. You can accomplish that by doing one of two things – plan to retain family ownership and management control, or retain family ownership but not management control. Either way, it calls for a plan.
Own and manage
All businesses need a succession plan, and everyone agrees that they’re hard to devise. Unfortunately, family business succession planning is “a unique management challenge because it deals with business, family, tax and estate issues while planning for the succession of both management and ownership,” says Nancy Bowman-Upton, author of the widely read Baylor University study. The transfer of ownership/management is the most common source of conflict in a family-owned business, she points out.
To retain family ownership and management control, you need to devise four distinct plans, says Bowman-Upton.
1. The business strategic plan – allows each generation an opportunity to chart a course for the business and provide a clear picture of its future.
2. The family strategic plan – establishes policies for the family’s role in the business and addresses issues important to the family.
3. The succession plan – Outlines how succession will occur and how to know when the successor is ready.
4. The estate plan – Critical for both the family and the business to avoid paying higher-than-necessary estate taxes, and to make sure the estate goes primarily to the designated heirs.
The succession plan can be problematic because it contains so many obstacles, including reluctance on the part of the founder/owner to give up power and control, and reluctance on the part of family members to discuss siblings’ positions and the death of their parents. Nonfamily employees who are likely to be fearful and uncertain, and longtime customers who have become overly dependent on the founder/owner also need to be factored into the mix.
The obstacles can be overcome, says Bowman-Upton, through a process that contains four phases:
1. Initiation – A period of time during which the children learn about the family business. She recommends that it begin when the children are born, but also notes that it can occur later.
2. Selection – The process of choosing who will be the company’s leader in the next generation, often the most difficult step.
3. Education – Bowman-Upton recommends using a trainer who is not necessarily the founder/owner to educate the successor. The person should be “logical, committed to the task, credible and action-oriented,” and should use “a program that is mission-aligned, result-oriented, reality-driven, learner-centered and risk-sensitive.”
4. Transition – The actual transfer of power to the successor, which can be gradual or abrupt, but should always be timely and final.
Own, not manage
If the succession plan calls for ownership of the company to remain with the family, but management responsibility will be passed on to a nonfamily member, the four-step process of initiation, selection, education and transition remains much the same. The difference is in the selection and the grooming of the successor.
“Succession Planning for Family Businesses,” an article produced by Wells Fargo, provides some tips based on successful practices used by other companies in this situation. One recommendation calls for distributing the responsibility for planning and executing the succession among a group of people – current employees, other family members, a neutral third party – instead of having it rest on a single individual, the founder/owner. Benefits of this multilevel approach include a sense of ownership on the part of employees along with acceptance of the results, and the perception that the succession planning is fair. The next step would be to establish a set of key leadership criteria to help identify potential successors with the greatest potential.
Communicating with employees about career planning and development opportunities also helps identify possible candidates. Wells Fargo recommends screening them by conducting formal succession planning reviews annually, combined with collecting informal feedback on a continual basis. By doing so, the company can measure the results of the individuals’ career paths and the succession plan to make sure succession goals are being met.
Anyone who has founded, nurtured and grown a business will discover that bowing out is difficult. Fear of changing financial status is a big factor, and with family businesses, owners also face the loss of overlapping family and business roles.
“Many owners find a gradual exit less disconcerting than an abrupt one,” said Wells Fargo. “The new owner often welcomes, and may even insist on, continued involvement by the former owner for a period of time to smooth the transition. This is generally done through an employment contract or consulting agreement. This same approach can work when the successor is a family member, but the scope of the former owner’s involvement and the time it will last should be spelled out in a written agreement and adhered to strictly.”
What does it take to successfully pull the plug? The entrepreneurs who face the fewest problems in turning over the reigns, says Nancy Bowman-Upton, are those who have a sound financial plan for retirement, are involved in activities outside the business that provide opportunities for social contact and exercise of personal power, have confidence in their designated successor and a willingness to listen to outside advisors.
Why Are Family Businesses so Conflicted?
In the U.S., about 90 percent of all businesses are family owned or controlled, and they range in size from the traditionally small to one-third of those listed on the Fortune 500. “It is estimated that family businesses generate about half of the country’s Gross National Product and half of the total wages paid,” said Professor Nancy Bowman-Upton, director of the Institute for Family Business at Baylor University. “The American economy depends heavily on the continuity and success of the family business. It is unfortunate, even alarming, that such a vital force has such a poor survival rate.”
Conflict is inherent in family businesses, she noted, because the family members involved must operate in two separate, but overlapping working worlds: the task system (the business itself), and the family system.
The business system is unemotional and contractually based. Roles in the business, such as president, manager and employee, carry specific responsibilities and expectations. The family system, however, is emotional. It stresses relationships, and rewards loyalty with love and care. Like the roles in business, family roles – husband/father, wife/mother, child/brother/sister – also come with specific responsibilities and expectations. The dual roles of task and family differ greatly and are often in conflict. Each has its own set of rules, along with communication, decision-making and conflict-resolution styles.