Strictly Professional

For the next generation, family-business survival rests squarely on formalized governance

Back Longreads Sep 22, 2015 By Jeff Wilser

There’s an old saying about family businesses: Shirtsleeves to shirtsleeves in three generations. Grandpa hustles and creates the business, Dad takes the baton and then Junior goes down with the ship. According to the Family Firm Institute, just 30 percent of family businesses survive into their second generation, and only 10 percent make it to their third. Why do these firms fail? To be fair, the long-term odds for most companies aren’t great. Whether owned by Ma and Pa or Wall Street, it’s never easy. But families face a unique set of challenges.

After surveying more than 2,000 family-owned businesses, PricewaterhouseCoopers unleashed a suite of reports suggesting a lack of governance and professionalism — more than any other factors — separate the firms that thrive from the firms that crumble. “As companies grow, they need to become a bit more formal in their entrepreneurship than they were during their startup days,” explains PWC in its 2015 family business survey. “How? By bringing greater rigor to their decision-making and operations.”

If you’re a small-business owner, it’s easy to hear words like “governance,” roll your eyes and think of the red tape, bureaucracy and tedious cube-think that repulses entrepreneurs. Fair. But the right professionalization and governance can save your company cash, boost its odds of survival and even save the family itself.

So what exactly are we talking about anyway? In this context, governance relates to who’s in charge and how they lead. Its scope includes ethics, accountability, management controls and succession planning. Professionalizing is the creation and implementation of the processes and procedures that govern the people in charge. These two elements overlap constantly in business, so it’s imperative that both are addressed equally and effectively.

“Most companies, typically, are going to be reasonably on top of operational issues. The area where they tend to have deferred maintenance is the formalization of their own governance. Not just of their own business but, frankly, over the family,” says Jay  Mattie, a partner at PWC who worked on the family-business analysis.

THE CASE FOR EXTERNAL GOVERNANCE

But creating a governing structure for a business, especially a large established business, takes time and an incredible amount of buy-in, often from team members who are also family and might be used to a different way of doing things (and uninterested in changing their ways).

In his research, Mattie found that tension most frequently stems from differences in generational perspectives. “It’s usually a strong-willed CEO who says, ‘I’ve been doing this for a long time, and it’s worked for me, why should I change?’ And then the younger generation might have a more global view,” he says, adding that just as millennials are more likely to consult Twitter for advice, they’re also more open to bringing in an external board of directors.

Poor planning can be costly and, according to Robert Rivinius, executive director of Sacramento’s Family Business Association, an outside perspective is often essential when a family-owned firm wants to implement more structure. That’s where external governance kicks in. An infusion of fresh blood — blood that, critically, is not actual family blood — can spark new ideas and challenge old assumptions.

“It needs to be written down. On a document. Not just something verbal, like, ‘Oh, I think Uncle Joe wanted Sally to be the next leader.’ Writing down a succession plan is as important as writing down a strategic business plan. You need to have both.” Lois Lang, family business consultant, Evolve Partner Group

Families that don’t do enough planning — or don’t use enough outside help — can expose themselves to financial ramifications, Rivinius says. He cites the federal income tax, California’s Prop. 13 for commercial property and a litany of other legal pitfalls as reason to seek third-party expertise. “These days, with the complex society and government we have, if you don’t really watch it, sooner or later it’s going to bite you.”

And it’s not just internal relationships that benefit from third-party insight. On a macro level, the world is changing. Today, a local shoemaker that opened in 1978 doesn’t just compete with neighboring shops in Roseville or Stockton; it now competes with Amazon, Walmart and thousands of other retailers from Boston to Beijing. In fact, 68 percent of family businesses are now exporting, according to PWC. “As companies attempt to compete globally, they just can’t do it alone,” says Mattie. “To try and know everything you need to know about all the challenges facing firms today, compared to 20 years ago, is just impossible.”

Without expert assistance, even maintaining the basics can seem impossible. “Business life is more complex, product lifecycles are shorter, and family firms, in particular, might find it difficult to keep pace, especially with new technology,” argues PWC. “The generation now running family firms may not be familiar with using new technology or see the value in acquiring it.”

Beyond the creation of an external board of directors, businesses can also hire consultants, interim directors or an external CEO. These unbiased experts could be invaluable when it comes to addressing the most crucial, existential issue facing the long-term health of any family business: succession planning.

PASSING THE TORCH THROUGH INTERNAL GOVERNANCE

Just as the lack of a suitable heir could topple a dynasty (see: the Tudors), the lack of a clear, concrete and documented succession plan can doom a company. “Succession planning is absolutely critical,” says Chris Glassman of Sacramento-based consulting group Leadership One, which focuses on family business. “Without it, there is no plan. Without it, the company is in reactive mode, making panicked decisions in emergencies.”

The pesky thing about a family business is that you have to deal with family. And to paraphrase Tolstoy, all happy family businesses are alike, but each unhappy family business is unhappy in its own way. “This is a really, really touchy area,” Lang says. “Succession can create a lot of family disharmony if not handled correctly. They don’t want to hurt the feelings of the next generation. Spouses get involved with their own opinions. And you’re talking about the mortality of the company’s owner. Who wants to think about death?”

“Succession is a perennial — and thorny — issue for family businesses. More often than not, they take a ‘hear no evil, see no evil’ approach to the topic. In other words, they fail to approach the topic at all,” explains the PWC report. “This ends up signaling uncertainty to the outside world (customers, competitors, employees, suppliers, etc.), which can have potentially adverse effects on both the company’s near-term health and its longevity. In extreme cases, it can lead to a complete disconnect between what the incumbent leader is privately planning and what the next generation is expecting.”

Too many firms simply haven’t done their homework. PWC found that only 21 percent of companies have a succession plan for all senior roles; 28 percent have a plan for most senior roles, and 47 percent either have only a very limited plan or no plan at all. “The firms that manage succession well are those that plan many years ahead,” advises the PWC report. “Ideally, that preparation should begin five to seven years in advance.”

Lois Lang is a consultant at Evolve Partner Group in Stockton and focuses on family businesses. When she meets new clients, the very first thing she asks is whether they have a succession plan. “It needs to be written down. On a document,” she says. “Not just something verbal, like, ‘Oh, I think Uncle Joe wanted Sally to be the next leader.’ Writing down a succession plan is as important as writing down a strategic business plan. You need to have both.”

Lang estimates that while 60- to 80 percent of her clients said they had a written business strategy, only 10- to 20 percent had a formal plan for succession. This has consequences. What if the owner dies with no clear heir? What if the younger sister is more qualified than the older brother? What if the widow wants to sell?

“There’s a natural conflict that arises in transition between generations,” Mattie says. “One family member might say, ‘I don’t want to own the shares any more. I want the $100,000 those shares are worth.’ How do you deal with that need for liquidity? And how do companies go back to the family tree and do a little bit of pruning, if you will? If you wait until there’s a death in the family, those shares might cause a major tax to be incurred, and all of a sudden somebody has to sell shares to pay a death tax. This can be the demise of a company.”

A good succession plan, according to Lang, does more than just tap the next CEO. It involves the top echelon of management. “I tell my clients to write out an org chart with the top five to 12 positions and then put the dates of retirement beside each name and next to that, the name of their successors,” she says. This forward thinking comes with a happy side effect: nudg-ing the company to invest in training. “In many family businesses, there’s business interruption,” Lang says. If the only person who knows how to use your website’s content management system leaves, there’s a gap. “Whenever there’s movement, if people aren’t cross-trained or if they aren’t developed, then there’s not enough bandwidth to expand a product or expand to another market.” Every company needs a strong bench.

PUT RULES ON THE FAMILY MATTERS

In any family business, says Glassman, there can be a tension between efficiency and harmony. Sometimes the two go hand in hand, but not always. Think about how, when you’re driving to a restaurant, Dad might insist on taking a “short-cut.” You know it will add 10 minutes. You could press the point to boost your efficiency, but sometimes it’s better to just take the longer route and preserve harmony. “In family business, we sometimes put in workarounds to keep harmony in place,” Glassman says. “For example, maybe a cousin doesn’t pull his weight, but we look the other way because he’s family.”

This is what the Boston Consulting Group’s George Stalk calls the No. 1 trap of family businesses: “saying, ‘There’s always a place for you here.’” To escape the trap? Rules. Regulations. Professionalization. “A job with the company shouldn’t be an entitlement,” he argues in the Harvard Business Review. “Those who want to join deserve no special accommodation. We now see an emerging best practice in which families formally require any child who wants a job to (a) earn a university degree, and in some cases a graduate degree, (b) gain several years of relevant professional experience outside the family business and © apply for open positions in competition with nonfamily applicants.”

Some family businesses also face relatives who acquire equity in the company without ever lifting a finger. This can complicate things. PWC found that 60 percent of companies had family members who hold an ownership interest without working for it. So what happens when Aunt Judy, who owns a 20-percent share but doesn’t do anything, has a conflict with Bill, who has 30 years of experience?  Without rules, we have chaos.

“Professionalizing the family involves putting processes in place to deal with these issues, as well as govern other ways that the family interacts with the business,” advises the PWC report.

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