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Meeting the Future with Confidence

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A group of Family Business magazine's distinguished contributing editors offer their best advice on how to get your family company in shape for the new century.

By Family Business Magazine editors

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PLAN, PROFESSIONALIZE, AND GROW THE PIE

Ernesto J. Poza, Weatherhead School of Management Case Western Reserve University Cleveland, OH

There is a widespread myth that unless you are a very large, diversified multinational corporation, you are prehistoric and on the road to extinction. Ironically this myth is often promoted on the business pages of family-controlled newspapers. Yet today’s global, competitive dynamics suggest that agile, niche-focused, high-quality, high customer- service providers—the profile of so many successful family businesses—are likely to thrive rather than decline. Witness companies we know and trust such as Smucker’s, Perdue Farms, Timken Steel, Marriott, American Greetings, Kohler, Asplundh Tree, Nordstrom, and thousands of smaller and less well-known but equally successful family businesses. These are the companies that build our homes and office buildings, produce and sell us much of what we buy at retail, and provide us with services we depend on in our daily lives.

Yet it has never been harder to achieve family business continuity. Why?

•   Because product life cycles are shrinking quickly. This means that as a result of new technology, product substitution, and new distribution channels, you have to renew your product more often or face the prospects of competing on price, not on quality or features that distinguish your product from the competition.

•   Because high current valuations of many family businesses create a strong temptation to sell, particularly if the owning family is not explicitly committed to continuity. I have seen the multiple on earnings on company sales in one industry jump from about five to about nine in the last decade.

•   Because many in the next generation have not learned the value of compromise and accommodation in the interest of achieving a larger purpose or goal. In fact, unless they have learned to be team players through sports, family, or church experiences, they are likely to focus exclusively on “what’s in it for me.”

•   Because the current generation of leaders is living longer. Why quit at 60 or 65, these seniors ask, when the odds are that they’ll be healthy and full of energy for more than another decade? Many seniors may be unwilling to consider retiring or a change in responsibilities in order to let the next generation make its mark and contribute to the business.

Family businesses capable of planning, and confident that each generation will responsibly bring a different but complementary vision to the business, have a foundation on which to build continuity. And a growing body of research (including the Weatherhead School of Management’s Discovery Research on Family Business) is identifying a set of best practices to help them build an enterprise that lasts. These best practices include:

•   Devising strategies that seek out growth opportunities. By growing the pie, you create win-win opportunities for shareholders, nonfamily employees, suppliers, distributors, and of course, customers. The McIlhennys of Tabasco sauce fame, for instance, seeing that a shrinking dividend pool was causing increased disharmony among shareholders, didn’t go out and hire a conflict-resolution consultant. Instead, they grew the business through product-line extensions of the already famous hot sauce in a bottle.

•   Complementing the skills and core competencies of owner-managers with those of key nonfamily management. In a global economy, a single family seldom has a monopoly on skills. In fact, some family employees don’t even meet minimum standards for employment. The best way to ensure your firm’s competitive fitness and continuity is to hire top-notch people and professionalize the company, while keeping incompetent or unmotivated family members out of it.

•   Developing estate transfer plans that emphasize corporate control and nimble management, not just tax savings. Financial advisers often recommend trusts and other estate planning vehicles to help you reduce your tax bill. But do you invest with tax savings or total return in mind? Owners who create their estate plans with tax savings as a priority often get what they deserve—a lower tax bill and a business that does not survive them.

•   Promoting ample understanding, communication, and planning of the transition across generations through frequent family meetings or family retreats. The disciplined execution of this approach, by forming a family council, allows a company to educate inactive shareholders, as well as active ones, about business and estate matters, as if with a tailored “family MBA program.”

•   Raising the bar for owner-managers by having a board of directors or board of advisers that includes influential outsiders. Moreso than family members or your own attorney and accountant, outside directors are capable of holding you, the owner, accountable. They also bring in a measure of objectivity that is invaluable in successor development, successor selection, succession planning, and contingency planning in case of a crisis. Most multigenerational family businesses I know list their independent board as a key reason for their continued success.

OLD SOLDIERS SHOULD LET GO IN TIME

Joe M. Goodman, Holton Howard & Goodman Nashville, TN

Sixty years ago the life expectancy in the United States for a newborn male was 58 years and for a newborn female, 62 years. Today life expectancy is 72 and 79 years, respectively. Longevity is projected to further increase in future years. Technological and scientific advances in medicine and health care have given us the gift of longer life. This can be a blessing to the family business—or a curse.

If the senior generation maintains control of the business or other substantial financial assets until death of the surviving spouse, many family companies will suffer a decline. The longer people live, the more they’ll be vulnerable to the physical and mental infirmities associated with age, among them depression, paranoia, dementia and Alzheimer’s disease.  Unfortunately, the estate and financial plans of business-owning couples often provide for them to retain control of, and exclusive financial benefit from, significant assets for both their lifetimes. Many aging business owners leave business assets to spouses who are themselves suffering from the effects of age; or, worse, they divert resources to a companion of their later years, to opportunistic charities, or to children who exert undue influence on them. This can result in misallocation and waste of valuable resources that can be better used by members of the next generation—for their own personal betterment or for the growth and continuity of the family business.

Even when all planning failed in the past, the death or disability of an aging owner inevitably precipitated a leadership change at the top that was often necessary to reinvigorate a business. With the aging of the population, however, family businesses can no longer count on being rescued by the hand of fate.

When grandparents pass their 80th birthday, they are typically balancing the needs and interests of three or four concurrent generations of family members. What if they continue to hang onto significant financial assets or family business stock (as many do)? Is it logical or healthy for “children” to have to wait until they are 60 or more before they receive power, money, or control of the business? How many people with outstanding leadership ability are willing to wait around that long?

Family business owners are challenged to be more enlightened in the preparation of estate and financial plans. Be cautious about lifetime trusts resulting in inefficient use of significant financial assets. Avoid placing power and control in the hands of older family members when they may dissipate or misuse these assets because of illness or mental deterioration.

For the sake of their families and organizations, business owners have to start planning earlier and prepare themselves to turn over the reins to the next generation at a reasonable age. At the same time, our social institutions can do more to help these senior owners overcome some of the handicaps of age. It’s ironic that we expend so much time and effort on improving the mental capabilities of our teenagers and young adults, while virtually ignoring the mental limitations that develop at the other end of life’s spectrum, which can have just as big an impact.

FIND WAYS TO GET THE KIDS INVOLVED NOW

Patricia A. Frishkoff, Austin Family Business Program Oregon State University Portland, OR

Parents have to start earlier to introduce their children to the business and convey its positive, joyful aspects. It sounds like a small thing, but it’s so important. In too many families, business owners bring home their complaints about their day at the office and forget to mention the part about passion.

It’s not intentional; most parents don’t even realize the negative slant to their early messages. If they want to do a better job at succession, however, parents will have be more conscious of the need to get members of the next generation involved and excited about the business as children. Be creative in devising the ways. For example:

•   Give your kids the same VIP tour of the plant and office as outsiders get. Then let them be the tour guides.

•   Does your business have a booth at community events? Hire the kids to build and staff it, with materials aimed at youth. And print business cards for them.

•   When you can, share the excitement of an industry trade show with them.

•   Develop an employment game plan for children who may want to join the business. They need to know what it takes to be part of the management team, before they begin college, so that as students, they can make wise choices. Does college matter? What should they major in? What about work experience? It’s the responsibility of the senior generation to define the requirements for entry into the business.

•   Involve them in decisions. Do you ever invite them to family meetings? You should. A session on the history of the business and legends of the founders is critical to their understanding of their heritage. Bring out all the old photos, letters, and examples of packaging for the company’s first products.

•   Considering a Web site? Since your kids probably use the Internet more than you do, ask for their suggestions. Are you philanthropic? Assign a small sum of money to the younger generation to make donations on their own; teach them how to evaluate proposals and make the biggest impact with their dollars.

•   Teach them about strategy and achieving results. Update young family members on your plans for the future, and help them set up a method for tracking results. One family has selected four measures of success; once every year the fourth-generation teens attend a meeting where results are presented in numbers and graphs.

If “someday it’ll all be theirs,” shouldn’t they learn the basics early?

CREATE A CULTURE OF CHANGE

John L. Ward, Kellogg Graduate School of Management Northwestern University, Evanston, IL

The years ahead promise even faster and more fundamental change for family firms. Industry consolidation, shrinking strategic life cycles, e-commerce, global competition, and revolutions in supply-chain management and logistics are just some of the well- known forces.

Rapid change threatens family owned firms more than other companies, for several reasons:

•   Family firms have deeply entrenched traditions.

•   Leaders typically serve long terms.

•   Family firms often profess cultures of loyalty, stability, and paternalism.

•   Long-time owners tend to be risk-averse.

•   Successors are reluctant to challenge predecessors’ philosophies and ways.

More than any business skill, future leaders of family firms will need to be leaders of change—without sacrificing the family’s values or the reputations of previous family leaders. No texts on leading change address this dilemma of protecting the past but changing the future. The key idea is to recast or reinterpret the past to emphasize that historic success was more a result of embracing change than it was the fruit of any particular strategies. To do so, some family firms have adopted and preached mottoes celebrating change. A few examples:

•   “Our tradition is change.”

•   “Innovation is our tradition.”

•   “Tradition is eternity, not history.”

•   “We believe in new ideas and old ideals.”

Once the firm’s tradition is portrayed as a culture of change, then that culture needs to be reinforced for the future. Ideas for doing so include the following:

•   Celebrate new ideas, even moreso than loyalty and tenure.

•   Stress dissatisfaction with the status quo.

•   Tinker constantly with management systems and practices.

•   Charge an independent board of directors with the responsibility to challenge strategic assumptions.

•   Share financial information with as many managers as possible.

Finally, leaders of family firms need to reassure the organization that the future will be exciting. Emphasizing an inspiring vision and a compelling philosophy of management gives employees confidence that change is possible, will lead to a better tomorrow, and is worth taking risks to accomplish.

LEARN WHAT SIBLING TEAMS REQUIRE

Barbara Dunn, Centre for Family Enterprise Glasgow Caledonian University Glasgow, Scotland

How to create and sustain a sibling partnership in the next generation is one of the greatest challenges facing family businesses as we approach 2000. This issue has been a primary thrust of our research since the launch of the Centre for Family Enterprise in 1995, and almost all the firms coming to us for educational programs and consulting services have been concerned with it.

Some of the parents that have contacted us have been seeking help prior to the transition, out of fear that their adult children might not be able to keep the business going and growing. The founding parents in one client firm wanted to set up a partnership among their three adult children. One of the three had a medical condition that will inevitably leave her unable to work. The parents’ hope was that financial security and an equal sibling ownership structure would create the conditions under which the three would take care of one another and compensate for each other’s’ weaknesses. But this hope was rapidly fading, since the siblings continued to have rows in and out of the workplace because of their rivalries and lack of experience. These parents had waited until it was too late to create an alternative succession plan.

Other client firms had been through the transition to a full-fledged sibling partnership and were learning that a lot of extra effort is needed to make it work, beyond the energy needed to keep the business on track. In one firm, the youngest sibling was the managing partner in an ownership group of five. For him, having the skill and experience to lead the business did not equate to being a credible and worthy leader in the eyes of his older siblings. The family hierarchy simply worked against him—causing him a great deal of pain.

It’s a sad reality that our work sometimes results in shattering the hopes and illusions of parents and adult children who have blindly set up or entered into the sibling partnership form of ownership. But it is also a reality that if we can reach families in business early enough, prior to their successions, they will have a clearer idea of whether this structure is right for them and likely to lead to a satisfactory life for the next generation.

Our research at the Centre suggests there are around 85,000 family firms in Scotland alone, and by the year 2000, 25 percent of them will have completed transitions to the next generation, many to sibling partnerships. Few have so far consulted professional advisers to prepare for these transitions, and those who did probably received little guidance beyond the legal-technical details of how to set up the partnership. With few exceptions, advisers we have interviewed show little awareness of the organizational and psychological needs of people entering such a team.

So for those of us in the family business field, here are some Big Hairy Audacious Goals for the next century:

•   For educators: Strive to find more effective ways of reaching families in business, long before the sibling partnership is seriously being considered.

•   For advisers: Bully your client base into thinking ahead; avoid the temptation to consult with only the controlling owner or senior partner; and study the topic of family business to show you really understand the dilemmas.

•   For governments: Make it imperative for family businesses to demonstrate responsible ownership and leadership of the business before they qualify for whatever tax relief and government subsidies your country offers.

•   For founders: Have the courage to ask yourself whether you’re setting up a sibling partnership more to meet your own need for a clear conscience than to meet the needs of your offspring and the business. Make sure you and they truly understand the pros and cons of life under this type of structure.

•   For siblings: Find out if you share enough common ground to want to go into partnership, and learn what it is likely to entail when you all get older and have different needs. If you decide to give it a try, negotiate exit routes that allow everyone to leave the business under honorable terms if and when they feel a need to move on.

DEFINE AND NURTURE MODEL SHAREHOLDERS

Ivan Lansberg, Ph.D. Lansberg Gersick & Associates New Haven, CT

The days of treating family shareholders like mushrooms—keeping them in the dark, feeding them manure, and chopping off their heads when they stick up too much—are over. There’s no greater challenge for family business owners in the coming years than learning to manage multiple shareholders effectively.

The demographic arrow points inexorably to increasing numbers of family businesses with complex ownership structures that include: family shareholders directly involved in executive roles; family shareholders who are not in management; and external shareholders who are purely investors. Traditional management theory and Warren Buffet may help business owners understand the issues of external investors, but they are hardly informative about the needs and concerns of family shareholders.

A distinction must be drawn between shareholders who are owners in fact and those who feel like owners. Legal ownership without a psychological sense of belonging and possession is hardly conducive to commitment and loyalty. Conversely, psychological ownership that is not “real”—based on actual control of stock—is ultimately experienced as hollow and phony.

Most business owners and their advisers are typically well versed in how to transfer real ownership to succeeding generations. Often, however, they don’t give much thought to how to nurture a psychological feeling of ownership, particularly among shareholders who don’t work in the business.

The first step is to articulate a profile of the kind of people the owners want as shareholders. What does an ideal family shareholder look like? Over the years, I’ve met and worked with a number of family shareholders who seemed to be effective in the role. They had a number of characteristics in common:

•   They cared deeply about the family and its legacy. They did not take the existence of an enterprise—nor the wealth it generated—for granted.

•   They were conscious of the sacrifices made by previous generations to build the company and create opportunities for them and the rest of the family. It is the caring of their forebears that motivated them to get involved with various governance responsibilities.

•   They were motivated by self-interest, but an enlightened self-interest stemming from an appreciation of the degree to which their well-being was interdependent with that of the rest of the family.

•   They understood what they owned. They had a working knowledge of the ownership structure of the business and the factors that determined it, and they were aware of the challenges and opportunities it might pose for the family as it evolved in the future.

•   They also understood the governance structure and the policies that regulate what they own. They were keenly sensitive to the fundamental distinction between governance and management. They knew how to play by the rules and use advisers to help them exert their legitimate influence in constructive ways.

•   They understood the need for lifelong learning and took the time to develop the basic skills necessary to function effectively in governance roles. They were sensitive to family dynamics and the need for effective communication. They schooled themselves in the financial details of the business as well as in wealth management; they also worked at achieving organizational and strategic literacy.

Family business leaders should articulate a profile for the kind of family owners they want. Without such a profile, their capacity to educate and develop shareholders who will wholeheartedly embrace the stewardship of a family enterprise will be limited at best.

Once created, the profile provides guidance in establishing the conditions necessary for family members who approach the ideal to emerge. This includes setting up ongoing modeling and mentoring as well as customized educational programs for current and future shareholders. Researchers and practitioners in the field can help by documenting best practices for developing model shareholders.

BE A BUYER, OR BE SOLD

Michael L. Fay, Hale and Dorr, Boston, MA

Large numbers of well-run, well-established family firms are still controlled by post- World War II and post-Korean War entrepreneurs who remain active, in varying degrees, in the day-to-day operation of their businesses. In many cases, the succession process in these firms will not be concluded until the founder dies. Thereafter, if the founder has undertaken suitable estate and business planning, members of the younger generation may continue to operate and control the family firm.

In most cases, however, the family firm will be put up for sale, either because the founder has not done adequate planning or because, despite sound planning, no one in the younger generation is both suitable and interested in operating the business.

The result is that a large number of well-run family firms will be available for purchase in the next 10 years. The sheer number of such businesses offered for sale might depress market prices, producing two results. First, for those who sell, the price achieved for a lifetime of effort may be disappointing, if not devastating. Second, family firms that have developed sound plans to continue family control for another generation and have adequate capital resources will find a plethora of opportunities to expand their operations through purchase of other family businesses at highly attractive prices.

Every family business owner should understand that the next decade will be the era of the opportunistic investor, and should ask one crucial question: “Which will my family be—a seller or a buyer?”

SHARPEN YOUR FINANCIAL MANAGEMENT

François M. de Visscher, de Visscher, Olson & Allen, Greenwich, CT

Rapid changes in the marketplace will only accelerate in the next century, and many family businesses are not prepared for the sophisticated financial challenges they will face. The globalization of markets, the increasing liquidity needs of shareholders, and the continued growth of communications technologies are but three of the massive shifts requiring family business owners to sharpen their financial acumen.

Such changes call first for professionalizing your financial management. Second, they make it essential to manage your cost of capital, both debt and equity, more efficiently.

Many family businesses continue to confuse the function of a controller or accounting manager with that of a chief financial officer. True CFOs fill multiple roles for family firms. They serve as your financial strategist; they’re familiar with the many sources of capital available; they map out ways to maximize shareholder value; and they manage your capital structure. Ideally, today’s CFO also has global capital market experience and perspective. Perhaps most important, because a CFO is at the fulcrum of business and family activity, he or she can often function as a peacekeeper, skillfully managing the desires of family members for liquidity and a return on their investment with the growth- capital needs of the business.

It’s time for family firms to truly entrust financial management to executives who are qualified by training and experience to manage these tasks, yet also have a sensitivity to and understanding of family dynamics.

One duty of an empowered CFO is to manage the cost of capital for the business. Managing the cost of debt requires broad access to borrowing sources by a professional skilled at tapping into diverse global capital markets. It will be up to the CFO to maintain relationships with multiple global borrowing sources, so that the family business can rapidly take advantage of growth opportunities, both domestic and foreign, and avoid pitfalls when the business climate is less rosy.

Managing the cost of equity is equally critical for family businesses entering the 21st century. Equity is the most expensive form of capital, and hence the comparative costs of various sources must be accurately assessed in order to avoid an excessive burden on the business. The company’s leaders should be aware that shares owned by family members—often referred to as patient equity capital—have a cost. Like any other investor, family shareholders expect a return on their capital, which they will measure in the form of current returns (dividends) plus the future appreciation in value of their stock.

Amid alluring reports of gains from Internet stocks and day-trading, next-generation shareholders are more inclined than their elders to evaluate their investment in a dispassionate manner—“What has my family business investment done for me lately?” Management ignores these expectations at its peril. ▪

Source:  Family Business Editors, Autumn 1999

Copyright © 1999. Family Business magazine. Subject to the provisions of the Terms and Conditions of the Family Business Web Site, subscribers to Family Business magazine may print and distribute copies of this article, electronically or otherwise, provided that (a) such printing and distribution is done only for your personal, informational, non-commercial purposes, and (b) you do not re-move or obscure the copyright notice or other notices. For other uses, including reprint permission for non-subscribers, contact Family Business magazine.