Power Centres of Family Businesses

I find myself writing once again on Family Businesses. I have written various Blog articles on Family Businesses, but I still face various issues with regards Family Businesses, that makes my blood boil. Add to that the fact that in the current circumstances Family Businesses need to get their act together to face adequately the challenges brought about by the pandemic.

I hear it many times. It is like a general advice one gives. Try to avoid working for Family Businesses. Many seem to dismiss family businesses as hotbeds of power playing, favor currying and back-stabbing environments. However, the world is peppered with examples of family businesses that have enjoyed success for decades, even centuries.

So which is it? Are family businesses prone to dramatic implosions, or are they some of the most enduring companies in existence? My answer to that is they can be both. They can be much more fragile or much more resilient than their peers. Given that family businesses—companies in which two or more family members exercise control, concurrently or sequentially—represent an estimated 85% of the world’s companies, ensuring their longevity is essential.

So what are the underlying reasons as to why certain family businesses thrive and keep on existing and growing from one generation to the next and others don’t?

In my opinion the answers lies in what I call the five “power centres” that the family ownership of a business has to decide upon. The reasons why certain family businesses fail normally always lie in failures in these “power centres” and hence the importance of getting these right for the family ownership. Understanding and deciding well on these “power centres” can lead to long-term success. Misunderstanding or misapplying them can destroy what a family has spent generations building.

The five “power centres” that the family ownership need to decide upon are:-

  1. Design: What type of ownership do you want?
  2. Decide: How will you structure governance?
  3. Value: How will you define success?
  4. Inform: What will—and won’t—you communicate?
  5. Transfer: How will you handle the transition to the next generation?

What Type of Ownership Do You Want?
Family businesses are often lumped together as if they were all the same. But in essence there are four fundamentally different ownership types, distinguished by who can be an owner and how owners share control. If you want your family business to last for generations, you need to understand the characteristics of your type and the strengths and challenges associated with it. The choice of ownership type isn’t a mere legal formality; it can define or restrict various members’ involvement and may loom as an unrecognized source of conflict. These four different ownership types are:-

  • Sole owner: One family member owns the company and is responsible for all decisions. This works best when the business requires decisive leadership and creates enough liquidity to satisfy nonowners (or when nonbusiness assets can do so). Sole ownership has downsides: Succession becomes a central issue, which may be decided according to merit (as assessed by the current owner) or assigned by primogeniture or a similar rule, and the owner must wrestle with what benefits to extend to other family members. This model can be risky, because much of the family’s capital and talent exit in each generation.
  • Partnership: Ownership is restricted to family members actively working in the business. This allows for multiple perspectives and requires clear rules governing how people can join or leave the ownership group and what benefits accrue to non-owners. Like sole ownerships, partnerships keep family owners highly engaged but can be vulnerable to the loss of capital and talent. They are typically more resilient because they don’t rely on just one leader, but they may face conflict over who is admitted to ownership.
  • Distributed ownership: Any family member may be an owner and participate in decision-making. This works well when most of the family wealth resides in the company, when it is mandated by law, or when it is expected by family culture. With no need to buy out non-owner members, distributed ownership can keep family capital tied to the business. But owners may vary in engagement; aligning their interests and defining decision-making norms can be challenging, and resentment about “free riders” may arise if some are operating the business while others are “only” investors. Big problems may crop up if some members of the family want to cash out; having a clearly defined exit ramp reduces that risk.
  • Concentrated ownership: Any family member may be an owner, but a subset controls decision-making. This works well when decisive action is required despite a multiplicity of owners, and it mitigates some of the challenges of distributed ownership. But the question of who will exercise control becomes more complicated with each new generation. In such companies, shares are normally passed down to descendants, but in each generation the CEO must own or control a majority of voting shares. Although the owners aim for consensus on big decisions, the CEO makes the final call. One of the chief risks is conflict over who will lead. Another is the possibility that those not in power will lose interest and sell their shares.

Although hybrids exist, most family businesses fall into one of those four categories. One other word of advice is that the type of ownership needn’t be a static choice. Be on the lookout for the need to make a change, which may arise when the next generation is joining, when the size or complexity of the business alters significantly, or when you’re bringing in outside leaders.

How Will You Structure Governance?
The owners of family businesses wield profound decision-making power. I see cases of companies in which not a single cent can be spent without the approval of the family owners. When this power is channeled appropriately, it confers a major competitive advantage, facilitating the nimbleness needed to capitalize on opportunities as they arise. Many family business leaders can make big bets at a moment’s notice, without having to run decisions through multiple layers of management and bureaucracy and to be honest speed of response is becoming more crucial in the present circumstances.

However, if that power is wielded ineffectively, the business will suffer. Some owners exercise too much control, stifling innovation and making it hard to attract and retain great talent. Others step back from major decisions, leaving a vacuum that may be filled by executives looking to their own interests. I unfortunately have seen a number of family businesses nearly destroyed when vital information and decisions were taken by non-family managers who had other personal interests rather than whats best for the family business.

In my humble opinion, governance in a family business is all about finding a middle ground between micromanaging and abdicating responsibility, and this becomes more challenging as the family and the business grow. Hence the importance that each family business has a simple framework to guide decision-making. In a well-run family business, such framework determines who belongs where and what decisions are made by whom. Time and again, I have seen and still see family businesses slide into chaos for lack of a good decision-making process. Too often the problem becomes apparent only after disagreements have begun to destroy what years of collaboration built.

How Will You Define Success?
The owners of any business have a right to the residual value it creates. With that right comes the ability to define success. For non-family businesses that’s straightforward. Success is the maximisation of shareholders’ returns. But family businesses could decide to have other more important objectives that they would classify under “success”. That’s one of the best things about family ownership: They get to determine what matters most. No outsider can force them to value earnings growth more highly than, say, providing family members with employment. Effectively exercising this right can be an incredible advantage in making a business last. It enables a long-term, generational approach that contrasts sharply with non-family owned companies’ obsession with just financial results.

However, the main issue I see is that not all families are clear about what they value most. That lack of clarity can trigger battles over priorities, missed opportunities or a failure to retain talented employees. More fundamentally, if the family ownership are unclear about their objectives, they risk losing their “raison d’être” for being in business together, especially as the company grows and transitions to new generations, leading to a dead end. To avoid that end, family businesses need to identify concrete goals and sets up performance measures. Goals could be “aiming for growth: maximizing financial value” or otherwise “Prioritising a healthy cash flow for the owners’ use outside the business” or even “Keeping decision-making authority firmly within the family ownership by avoiding outside equity or debt.” There will be obvious trade-offs among these options. What’s most important is understanding the explicit and implicit choices family businesses are making about what to prioritise and that these should flow from the fundamental values of the family ownership.

However whilst outlining such priorities and goals is essential, without concrete ways of measuring performance, it’s just lip service. These measures of performance are important to ensure that those running the business are directing their energy and resources toward what the family owners care about most. They would also allow the family ownership to delegate decisions more confidently. Such measures of performance can be financial or nonfinancial. Family ownership should at least home in on a small number of financial ones—for example, minimum levels of return on invested capital or maximum levels of debt—and ensure that the company stays within them. Non-financial measures of performance would then define outcomes for which family owners are willing to sacrifice financial performance for.

What Will—and Won’t—You Communicate?
Family business owners are legally entitled to know a great deal about their business, such as what’s in financial statements. Unless its the case of bringing in outside investors, lenders or board members, they are not obligated to share that information with anyone (other than the government/tax department). That means that the family ownership can control communication and hence nothing of consequence can be shared without their permission.

How family owners exercise this right significantly affects the business’s longevity. That’s because effective communication is critical to building one of a family business’s most valuable assets: trusted relationships. These are often underappreciated, but they help generate three important things:

  • Financial capital: committed owners who have an emotional connection to the business and value long-term performance.
  • Human capital: engaged employees and family members, including spouses, who bring their full talents to their work and the family.
  • Social capital: a positive reputation with customers, suppliers and other stakeholders, who can help differentiate you in a crowded marketplace and build partnerships across generations.

The impulse to keep things private is understandable. Privacy can protect the business and the family from outsiders. But if owners hold their cards too close to the vest, they risk starving the business of its ability to cultivate valuable relationships.

Early on in the life of family businesses, communication is likely to be informal, perhaps taking place over meals. As things progress, family businesses need to consider what meetings, policies, functions, or technological platforms could improve their communication and dialogues. In my experience, owners are often so worried about protecting details regarding their wealth that they fail to think through what they can share to help stakeholders feel connected to the business’s long-term success. Such information might include the owner values and strategy, how decisions will be made, how you think about succession, and your passion for the business. If you decide to keep such information private, I suggest you tell your stakeholders why. I see cases where the failure to communicate effectively is the single biggest reason for a family business’s difficulties. Hence the final message to family businesses to to use the right to inform wisely.

How Will You Handle the Transition to the Next Generation?

My message here is simple. Delaying or poorly planning a transition to the next generation can wreak havoc on the family and the business alike. Many delay thinking and planning about this to their peril. Decisions and planning on who will own the business next, what form that ownership will take and when the transition will occur cannot happen to soon. Such planning will help give answers to difficult questions like: What will you do with the assets that the present family owners worked so hard to build? How and when will the present family ownership let go? What roles should members of the next generation play, now and in the future? How should you prepare them? Are the relationships among the next generation individuals strong enough that they can work through decisions together?

Due to the complexity, I always advice that the execution of a successful transition, requires a continuity plan that maps a path from the current generation of owners to the next. Such a continuity plan should address these challenges: Will you keep the same type of ownership (sole owner, partnership, and so on) or change it? Will you transfer ownership all at once or gradually? How will you create the glide path necessary for the current leaders to let go? How will you select successors across in a way that feels fair and identifies the most-talented candidates? How will you ensure a smooth passing of the baton? What skills will each of the new owners need, whether they actively work in the business or not? How will you help them identify the roles for which they are best suited? How will you create opportunities for them to learn how to collaborate with one another?

Transition is a process, not an event—and the more the continuity plan resembles a discussion rather than an ultimatum, the greater the chances of success. The plan can’t simply be dictated from one generation to the next; incoming leaders need to be prepared and aligned. Often the biggest hurdle to continuity planning is getting started. When facing pressing concerns in the present, it can be tempting to put off cross-generational conversations. So put these conversations on your agenda and set some deadlines for them.

I will not sugarcoat the bottom line. Without hard and smart work by the family owners and other key stakeholders, family businesses often implode. Much energy is needed to keep the many competing interests from turning destructive. There is no single way to survive, and there are few universal best practices. But by making sure that the above mentioned five “power centres” are in check, the family ownership of the business can organise itself for the work that is required. It is the only way where the power of family ownership can be used to sustain a family business for generations to come.

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