Family is Like a Built-In Drama — 3 Tips for Making Family Business Transitions Harmonious Separating the family business from the business of the family can be tricky, but preserving family harmony even as you transition away from your business is possible.
By Mark Bell, Ph.D. Edited by Micah Zimmerman
Key Takeaways
- Align compensation with contribution: no free rides, even for family.
- Clear incentives create loyalty; misplaced ones create freeloaders and family drama.
Opinions expressed by Entrepreneur contributors are their own.
Every business owner likely knows the dangers of family feuds and litigation, especially when dealing with a large, illiquid asset like a closely held business. Getting all family members aligned around the same set of goals can be complicated, especially when considering the exponential growth of family members over generations.
Nevertheless, the alignment of family harmony and business interests can be achieved by borrowing from a time-tested process. Business Strategy 101 tells us that shareholder value is ultimately measured by a company's ability to gain and sustain a competitive advantage in its market segment. It is measured by generating above-industry financial metrics. Not every business generates a competitive advantage, but most strive to do so.
But how did you arrive where you are today? You probably used a variation on the ideas below as you built your business. Imagine how the same principles you used to develop a competitive advantage in your business might be applied to your family to preserve harmony and successfully transition ownership of your company.
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1. Spend time on your strategic vision
Our experience advising families for a generation is that in business, the never-ending questions are 'What's happening in our industry? How are we positioned, and what must we do to gain and sustain a competitive advantage?'
In our experience, successful entrepreneurs continuously undertake a S-WOT analysis to identify Strengths, Weaknesses, Opportunities and Threats to their business. We often work with companies to identify the gaps between the optimal and current state and develop a plan for implementation. Then, we monitor progress and make adjustments to keep our plan on track.
Successful families ask similar questions. As we look down the road of life, what is happening with our family? How are we positioned to meet the financial objectives of all shareholders while maintaining the fundamental principles that keep the business competitive?
Developing a SWOT analysis for a family will reveal gaps between optimal and current state, and we can identify ways to create alignment between the shareholders' needs and those of the business. A well-developed family guide and a well-designed questionnaire can be deployed so that the business owner/head of the family can solicit the voices of many family members to help define a strategic vision for the family, guided by a mission statement, rules of the road, and a code of conduct.
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2. Provide the financial and leadership resources to execute the strategic vision
In business, a competitive position can erode due to a failure to anticipate changing leadership and financial resource needs. Highly strategic companies are well prepared to adapt quickly. Given the age demographics of the owners of most private companies (approximately half are over age 55), developing a management transition plan that identifies, trains and develops future leaders is a huge value-driver, irrespective of whether you keep or sell the business.
Similarly, successful families address the financial needs of current and future shareholders. Harmonious families ask: Who are the shareholders that are most optimally aligned with our family vision? How do we optimize assets both current and future shareholders need to meet their goals?"
Especially for business owners who are nearing retirement and desiring some liquidity, that goal may be at cross purposes with the needs of the business to reinvest for growth. These two objectives can more easily be aligned if you anticipate these changing dynamics before they become an issue. Addressing potential conflicts early and developing and communicating a plan to address them is just SMART (Saves Money And Reduces Tension). As a family, you can actually put the potential conflict to rest with an agreed upon, written buy-sell agreement.
Developing a family council is similar to developing a leadership transition team for the business. You identify, train, and develop the initial team of family council members. Their role is to understand and communicate to shareholders the business's needs, educate them on key financial planning issues, and create a plan to identify, train, and develop their replacements.
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3. Align incentives with strategic initiatives
One of the biggest gaps we see as business advisors is the lack of alignment between the incentive plans for key employees and the company's strategic initiatives. The old saying, "You get what you incent," is about as basic a business fundamental that exists but is often the largest impediment to the successful transition of a business.
Strategic business initiatives often change as the environment changes. Similarly, family shareholders need to know that their personal family strategic initiatives are aligned and that the decision-makers are meeting their fiduciary responsibilities to all shareholders by making changes as conditions change.
Two primary forms of cash flow from a company are W-2 (Wages/Compensation) and K-1 (Investor Return of Investment). Alignment occurs when you ensure fair market compensation (W-2) for family members running the company and offer the going rate for non-family personnel in the same role, thus not diluting the K-1 income to shareholders.
Owners should develop a dividend policy that ensures the company has the financial resources to compete and outlines how and when excess working capital can be distributed to shareholders. You might be fortunate enough to maintain a certain level of distributions so that each shareholder can incorporate those distributions into their personal financial planning, cash flow, diversification, and estate planning.
Finding your family harmony
Often, financial advisors use scary statistics on the failure rate of business and wealth transitions, the high cost of interfamily litigation and the destruction of what was once a happy, harmonious family. Furthermore, advisors often make it a mystery as to how you can even develop a plan for the family, which prevents business owners from getting started in the first place. The common refrain from unsuccessful attempts at family planning is, "We spent a lot of time and money, and it was a lot of touchy-feely, but we never put anything tangible in place."
While there will likely be bruises from family issues that will test even the best of plans, the only important statistic in the end is: Were you able to develop a successful succession plan or not?!
The same processes of integrating a vision, financial and leadership resources with aligned incentives and quality communications that made your business great can make your family happy and harmonious, too. An experienced family business advisor can take your proven and successful business model and help you adapt it for your family. You will quickly and more intuitively know how to identify cross-purpose dynamics and objectives and ways to close the gaps.
