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Preparing for Transfer of Ownership

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By Ivan Lansberg, Ph.D. & Maria Dolores Moreno, M.B.A. in Globe Business Publishing

1. INTRODUCTION

The transfer of ownership is one of the most significant events in the life of a family business. Over the past two decades many business families, especially those who own medium-to-large enterprises, have invested much time and resources preparing an orderly transition of their wealth and their enterprises. Many have adopted family constitutions and formal shareholders’ agreements to regulate the relationships among their heirs for generations to come. The Dickensian image of the family meeting at the lawyer’s office, to hear for the first time a relative’s last will and testament, is increasingly a thing of the past. Today, much emphasis is given to the creation of structures and organisational forms (such as trusts, holding companies, shareholder contracts and family protocols) with the hope that these mechanisms will minimise estate taxation and at the same time preserve family harmony in the future. While it is early to tell on the aggregate whether these instruments have in fact accomplished their intended purpose, our experience over 20 years working with business families is that these tools are certainly no panaceas: despite much effort to avoid inheritance and succession conflicts through formal legal arrangements, many business families still run into serious trouble during generational transitions. While we strongly support the notion that formal agreements and legal structures regulating owners are helpful and, indeed, often necessary for the successful continuity of a family enterprise, experience shows that these tools are certainly not sufficient. For there is no legal agreement or structure that, at the end of the day, does not depend on the good will and commitment of the people whose life it sets out to regulate. At first brush this may seem like a self-evident, if not obvious, idea. However, in the seemingly ‘messy’ process of generational transition many business owners and their advisors are often seduced by the tangible nature of the legalities. In these processes trusts, contracts and structures seem like terra firma in the sea of vague familial obligations, promises and good intentions.

Consider the case of a prominent business family who retained the services of a top estate lawyer and worked to forge an ‘iron-clad’ shareholders’ agreement. A few years into the transition the oldest of the three brothers died unexpectedly from a heart attack, triggering a wave of conflict that threatened to unravel the family and ultimately their enterprise. Shortly upon her husband’s death, his wife learned for the first time that the agreement stipulated that his shares of the family business would pass directly to their children—de facto leaving her out of the bulk of his inheritance. While she was to be the beneficiary of other assets, the fact that her children (rather than she) would now become shareholders in the family business felt as a deep betrayal and estranged her both from her in-laws and her own offspring. More importantly, the sudden unveiling of the shareholders’ agreement had repercussions with the surviving brothers’ spouses, who were shocked to learn that their husbands too had signed a legally binding document of such consequence without ever consulting them. Only after a prolonged mediation, through which the original shareholders’ agreement was renegotiated with ‘all the cards on the table’ and with the structured involvement of all relevant stakeholders, was the family able to heal the mistrust that ensued and recommit to the continuity of the family enterprise. As this family learned, no matter how strong (or well-intended) a shareholders’ agreement is, it can serve to undermine continuity if drawn in secrecy and without the informed (and understood) consent of the relevant stakeholders. As one of the brothers indicated: “The irony of this is that had we followed a different process—one that was transparent rather than shrouded in secrecy—we may have gotten to the same agreement but with very different outcomes…” The key is to structure the process so that it enhances trust.

The purpose of this chapter is to offer a guide to family business owners and their advisors about how best to manage the process through which future asset allocations priorities are defined and decisions about ownership transfers are made and formalised. Our fundamental premise is that the way formal agreements are drafted has a very significant impact on their practical enforceability and on either enhancing or undermining the commitment to continuity. While much attention has been paid to the content of ownership decisions—for example, what makes for better or worse shareholders’ agreements or trust architectures—few commentators have focused on how the process through which ownership choices are made ultimately influences the outcomes of continuity planning.

Specifically, we will suggest that, ideally, effective ownership transfers ought to follow a four step process:

  • preparing: setting the stage for ownership discussions;
  • visioning: getting current and future owners to articulate their aspirations and negotiate a shared vision across generations;
  • formalising: getting owners to document the agreements into legally binding contracts; and;
  • implementing: getting the owners to turn agreements on paper into living organisations.

2. PREPARING: SETTING THE STAGE FOR OWNERSHIP DISCUSSIONS

Imagine a family with little mountaineering knowledge or experience that was about to embark on a strenuous mountain crossing over the Alps. Imagine, further, that the family’s wealth, its emotional well-being, the realization of its deepest aspirations for the future as well as its stature in the community, all depended on the successful completion of the trek. Wouldn’t you advise the family to go out of its way to prepare for the journey? Wouldn’t you, at a minimum, give them the basic survival skills necessary to complete the crossing successfully? Of course you would. And yet, when it comes to decisions influencing the future ownership of their joint assets, most business families engage in just such a high-stakes journey with little or no preparation.

The starting point of any ownership transfer should always involve a period of grounding, coaching and preparation. The fundamental task of this initial stage is clarifying expectations about the process itself—Who will be involved? How long will it take? What information will they need? What homework will they need to do to understand the basic issues and choices at hand? What roadblocks and frustrations are they likely to encounter? How might they go about resolving their differences when these occur? Preparing a family for effective ownership transfer requires addressing these and many other process questions upfront.

It is important to ‘normalize’ and anticipate the generic challenges that business families typically face during these transitions, with the purpose of raising the family’s coping capacity. For example, helping a family to view the transfer of ownership, not just as a set of rational decisions with associated costs and benefits but also as choices that have emotional underpinnings is often useful. For instance, it is useful to inoculate the family to expect that these conversations are never easy even in the best of families. Indeed, the transfer of ownership can (and often does) trigger a deep sense of loss and affects the senior generation’s perceptions of control over their destiny, or even their sense of stature in the family’s hierarchy. Likewise, it is common for the junior generation to worry about coming across as greedy or ungrateful when discussing these issues with their parents. Moreover, in many cultures discussing the aftermath of the parents’ death is even equated with tempting fate.

The objective in the preparation stage is to frame the process such that it legitimizes the expression of ambivalence and emotion most families go through when faced with issues related to a transfer of ownership, and makes those aspects of the process an integral part of the work that, if managed constructively, can help establish a climate of trust among family members. Families need time to acknowledge and resolve their mixed feelings about these complex issues. Creating expectations that the process of ownership transfer will unfold in a tidy linear way often squanders the opportunity that it offers to educate the family and to build their capacity to understand, communicate and solve problems effectively. Naturally, this is not an argument for not structuring the process and providing direction; it is simply an acknowledgement that sometimes in this work the shortest distance between two points is not a straight line—the logical, the psychological and the interpersonal work must go hand in hand within the family.

It is often helpful to start the preparation process with an educational workshop that raises the family’s awareness of the generic content and process issues associated with ownership transitions and introduces a common language with which to engage in a shared exploration project. These workshops need to be staged carefully and with the active involvement of the family. The aim is to customize the issues to the family’s culture of origin, wealth and business portfolio, and stage of development. The workshop also serves as an efficient vehicle to develop a ‘psychological contract’ for the process to be followed. It clarifies expectations about the time horizon for the transition, the roles that everyone will need to play and the tasks that each individual is expected to perform.

It can be tempting for families to begin discussions about ownership transfers with the most difficult issues they have to resolve. However, rather than tackling the toughest subjects at the front end of the process, it is helpful to organize the agendas backwards so that family members begin with those topics that reinforce their shared identity and their common objectives and gradually build the level of confidence necessary to engage constructively on issues where their individual needs and aspirations might not be in alignment. For example, rather than starting the discussion with issues such as stock allocations between those who work in the business and those who do not, or how much wealth is to be passed on to each individual, it is better to start by discussing the family’s history with ownership transfers—what has gone well in the past and what has not; what lessons did family members draw from those experiences and how might they shape their expectations. Also, talking about the family’s shared values and how they wish to apply those values to their discussions of ownership in the future can also strengthen the family’s commitment to protecting the unity of the group even in families who may wish to ultimately separate their assets.

Another critical element of the preparation stage is gathering accurate information about the current ownership situation. Often, family enterprises grow in opportunistic ways over many years—new ventures are started, minority investments in other people’s business are made, joint ventures with partners in foreign jurisdictions are done, and land and buildings are purchased simply because opportunities to do so became available. It is not unusual for highly entrepreneurial families to end up with a complex, diverse and fragmented portfolio of investments and properties that have accumulated over time. Each one of these assets has a particular ownership structure (and a market value) that is frequently unknown to the family at the time when they start thinking about inheritance. In cultures in which conspicuous wealth exposes the family to political or personal risks, asset portfolios are deliberately kept under wraps. Also, past ownership decisions are often obfuscated by elusive memories. In many families the internal structure of ownership that was originally established for a particular entity or property might have been forgotten—a company was set up between a father and a son with the intention of bringing the others in later; a venture between two sisters excluded a third who was still too young; a spouse was kept out from an entity because the marriage at the time was going through a turbulent phase; children then unborn were not taken into account at the time a trust was formed; a friend who was named director of the holding has since died or moved away—are all quite common. Ownership documents are static and frozen at the time they were drafted; the family, its wealth, its enterprises and society at large (as well as the laws guiding ownership) are dynamic and continue to evolve. Families can quickly lose track of what they actually have. Forgotten as the original ownership documents might be psychologically, they remain legally binding until they are modified.

When it comes to ownership transfers, history matters. Unearthing and reconstructing the family’s portfolio of assets and capturing the assumptions that led to the original choices made can be a delicate task at the preparation stage. Often surprises emerge that can unintentionally affect the process. For example, when two sisters in a business family we worked with got to learn that, 15 years before, their father had given stock in the flagship business of the family only to the sons that worked with him in the company, they felt so excluded and betrayed that they were reluctant to participate in the discussions as to how the future ownership transfer would be carried out. Even though much had happened in the ensuing time (one of the brothers had started his own venture under the umbrella of family holding and the other had left the family business altogether), the original choices still stood. The parents, who did not even remember that these choices had been made long ago, quickly moved to explain to their daughters that the original assumptions no longer held true and that the whole purpose of the ownership planning process was to reconfigure the portfolio in a more fair and balanced way that reflected the current situation of the family. Again, ownership decisions and especially the underlying assumptions that drive them are frequently interpreted in emotional ways. Because of the precise and tangible nature of ownership, these issues can become the standard through which comparative assessments about who is loved the most are made. As in Shakespeare’s King Lear, rivalries among siblings, cousins and their spouses are rapidly fuelled by social comparisons within the family. If past ownership choices are not appropriately contextualised at the front end of the process, if the history is not revisited and reinterpreted in the context of the future, trust can be compromised and the process for resolving asset transfers constructively can derail even before it starts.

Past compensation practices—specifically, how family shareholders, directors and executives are remunerated—are without a doubt among the most difficult issues to uncover during the preparation stage. This is particularly so in transitions from a founder entrepreneur to his or her children. Entrepreneurs are typically ‘deal makers’ who thrive in making personal agreements with the key stakeholders that help cement their loyalty. In many first-generation family businesses there is a ‘secret chequebook’, controlled exclusively by the founder, that is used to compensate individuals in a variety of roles. Typically at this stage there is little distinction between salaries, bonuses, dividends and simply paternalistic gifts that the founder may feel like making to specific individuals at any point in time. In one family we worked with, the founder personally paid the salaries of his sons who worked in the business, and a monthly stipend to his daughters who did not work in the company and he was the only one who knew how much each was getting. Because the sons earned considerably more, the father was very hesitant to discuss past ‘compensation’ during the ownership transfer process, even though he realised that in order to clarify how the family would deal with this issue in the future past practices had to be revealed. However, when this issue was framed in the context of clarifying future privileges, rights, obligations and responsibilities of owners and managers as well as the different roles each would play in the future, the family was able to understand and discuss openly the reasons why different sources of remuneration existed—including the difference between executive salaries and bonuses on the one hand, and shareholder dividends on the other.

A critical task during the preparation stage involves not just documenting what the legal structure of ownership actually is, but also uncovering the gaps that may exist between the de facto structure and the proprietary family’s governance practices. Often long-established governance practices are not supported by the legal structure as family members and other stakeholders assume. For example, it is not unusual for a senior group of siblings or cousins to function explicitly as a shareholder assembly or even as a board of directors without actually having the legal right to do so. The discrepancy between the practice and the legal structure can become explicit when the unexpected happens—the founder of the business dies suddenly and the corporate bye-laws are actually read, or the tax authorities suddenly intervene and uncover who the legally liable parties to an alleged violation actually are. Here again, surprises can and do occur—as the heir of a prominent family told us: “Before they all died, my uncles established a board of directors with handpicked cousins from the next generation and empowered it to make all governance decisions. However, we did not discover that group was not a real board until we tried to fire an incompetent shareholder from the management of the business. As it turned out, the uncles had not bothered with making the appropriate legal changes to the corporate statutes and, when contested, we discovered that in fact we had little control to shape governance decisions after they were gone. We had to put the matter to a vote of all the shareholders and lost.”

In our experience, the upfront investment of time and resources made during the preparation stage needs to be explicitly conveyed to client families as an essential part of the process. Sometimes families, eager to put uncomfortable ownership discussions behind them and conscious of the costs involved in working with outside professionals, get impatient and want to get to the ‘real issues’ right away. Explaining the critical importance of this stage is very important to set the right tone for the process. As in matters of family health, the critical message here needs to be “an ounce of prevention can spare you a life time of pain…”.

 

3. VISIONING: GETTING CURRENT AND FUTURE OWNERS TO ARTICULATE THEIR ASPIRATIONS AND NEGOTIATE A SHARED VISION ACROSS GENERATIONS

Once a family has been educated about the process of ownership transfer and they have taken stock of what they own, they are ready to engage in the next step of the transition: imagining an ownership structure for the future.

Just as with the preparation phase, the work involved in visualizing an alternative ownership structure for the future of a business family is often dismissed and devalued as an unnecessary distraction. Against the backdrop of hard ownership choices—portfolio configuration and returns; inheritance allocations; governance architecture for corporate and trust structures; liquidity needs; and, especially, estate taxes—taking the time to articulate aspirations and dreams seems like an ephemeral and tangential task. And yet, customizing ownership solutions so that they resonate with the aspirations of current and future owners is essential for the successful implementation of any plan for the transfer of ownership.

Moreover, when the visioning work is done effectively, it serves to bond the commitment of the owners to their legacy and motivates them to invest in the responsible governance (and management) of their assets. The very fact of inviting the current and future owners to articulate their life aspirations and dreams at the front end of the ownership transition serves to legitimise the idea that continuity is always a choice and that the family’s wealth is, in part, a resource to support the lives they aspire to live. Indeed, when the life aspirations of the owners are articulated and used as a backdrop to frame inheritance choices, the design of ownership and governance structures, commitment to the enterprise and its continuity is enhanced.

However, getting the current and future owners to articulate what they want is seldom an easy task—this is particularly so when it comes to the future of their wealth and the ownership and governance structures built to support it. Research and experience suggest that humans in general—and business families in particular—are notoriously poor at defining desirable possibilities for their future lives. The cognitive effort necessary to conceive alternative scenarios for our lives that are unencumbered by our present experience is significant. Most fall prey to what Daniel Gilbert, the notable Harvard psychologist, calls ‘presentism’—the tendency to define our aspirations for the future in ways that are simply unimaginative extrapolations of the life we are currently living. The current existence of business owners imprisons their capacity to envisage alternatives: founding entrepreneurs actively seek out the child to succeed them who is most like them because they cannot fathom a system that is not led by a single charismatic leader; sibling owners look to replicate their fraternal ties in a complex network of cousins of widely dispersed ages and interests; families that have owned businesses for generations simply cannot visualize continuity without an operating business; and so forth. Presentism is unquestionably a mental trap that poses a challenge for business families wanting to design a future ownership structure.

Simply asking the owners point blank, “What do you want?” is often not all that helpful, either. Many owners do have vague conceptions of the future they wish for, but rarely do they devote the time and energy necessary to clearly define what it is that they want. While the seniors are typically so caught up in the momentum of their lives that it is hard for them to imagine an alternative, the juniors often do not even feel like they have permission to articulate their own life dreams in the context of the planning process. Some fear that exposing their aspirations to the rest of the family may elicit disapproval and criticism. Others may simply not be developmentally ready to know what they want at the time the planning process takes place. And yet, it is important to recognise that while the developmental planets might never quite be in perfect alignment, the planning process must nonetheless go forth. The fundamental recognition that there are no ‘silver bullets’ to solve all the nuances and potential complications associated with the transfer of ownership and wealth, is important. Every ‘solution’ engenders a new set of dilemmas and problems that need to be managed and resolved. Hence, the goal is not to find the perfect answer; it is to build the owning family’s capacity to understand, communicate and problem-solve effectively. As with gardening, this kind of planning requires a long-term mindset in which stretches of sustained attention and hard work—weeding, fertilising, watering and pruning—are punctuated by moments when the garden blooms. And then the cycle starts all over again as the family continues to develop and the circumstances change. Contrary to the ‘engineering’ mindset often espoused by the professions, the process of ownership transfer is not just a collection of tangible problems to be solved; it is an unfolding human drama with the potential to bring families together or drive them apart depending on how it is managed.

Its inherent messiness notwithstanding, the visioning process often benefits from being stimulated and structured in a building-block fashion: starting with opportunities for individual reflection, followed by facilitated conversations within and among couples. Cross-generational meetings that bring together the whole family, or particular segments of it, are also helpful and necessary. Sometimes the family’s imagination needs to be ‘seeded’ with questions, examples and case descriptions about the experience of others. Benchmarking visits with other families, who have already implemented ownership scenarios that might be unimaginable at the front end of the process, are often the best window into possible futures. In this work individual or group epiphanies are rare—the vision for the future ownership scenario usually emerges gradually out of a period of sustained reflection and exploration of possibilities.

Visioning is therefore an iterative process that involves a back and forth between individual reflection and collective dialogue over a protracted period of time. There are many reasons why this is so. For some families the process of visioning can be scary because it confronts them with the fact that not everyone may want the same thing. Naturally, working through these discrepancies is important. For other families, the process is hard because defining a new vision forces them to articulate what they want and, in so doing, give rise to fears of disappointment in the event that their aspirations cannot be realised. Sometimes, families may even deliberately keep their aspirations vague as a defence against their fear of failure. However, the fact that defining the future is difficult is not a reason not to do it. The natural aging process forces families to embark on a process of change whether or not they have chosen a destination for their journey. Their choice, in fact, is not whether to go on the journey; it is whether or not they want to manage the journey—by choosing a destination and marshalling the strategic and tactical skills, the resources and the energy necessary to get them from where they are to where they want to go.

The visioning process, if done thoughtfully, serves to further educate family members about the fundamental dilemmas and trade-offs associated with family enterprise continuity—for example, the trade-off between economies of scale and risk reduction associated with diversified aggregate wealth on the one hand and the loss of individual autonomy on the other that comes with the delegation of authority to the collective decision-making processes necessary to manage pooled assets. Similarly, the complexities associated with governing and managing aggregated wealth require a level of meritocratic professionalism that may exclude some of the owners from direct involvement in decisions about their wealth. As these tradeoffs become evident, individuals enhance their capacity to compromise and to accept the opportunities and risks that the family enterprise in the future might offer. The process itself also serves as a rehearsal of the future the family might be exploring. If, through the process of visioning, the family finds new ways of communicating and collaborating, and if their problem-solving capacity is enhanced through the planning process, then the possibility of a joint future is reinforced. But if the family cannot even bring itself to collaborate around the development of a new vision, then the natural conclusion might well be that separating the assets is in fact the best course of action. Not all business families are meant to be together.

The visioning process also requires assisting individuals in both generations to anticipate personal, financial and career issues. For the seniors, helping them to articulate dreams yet unrealised—things, if you will, that they would lament not having done before their death—and encouraging them to take those aspirations seriously, assisting them with fleshing out the practical steps that might be taken to realise them, is essential. It is common for seniors to underestimate the extent to which skills that they have honed over a lifetime in the family enterprise are applicable in new areas such as philanthropy, education, community institutions and politics. Often, the seniors need considerable coaching in thinking through the evolution of their roles away from day-to-day management and toward governance. As the chairman of a prominent family enterprise put it: “When we started this process I did not really understand what a chairman actually did and thought they were kicking me upstairs… I was so focused on operational decision-making that I did not realise all the hard work that governance involved…”.

Perhaps the most delicate visioning work with the seniors involves helping them with their financial planning. Getting them to anchor their cost-of-living assumptions on their actual historical pattern of expenditure; assisting them with estimating the income they will need in order to live their later years in the style to which they grown accustomed; helping them to articulate their philanthropic aspirations and the funds necessary to realise them; alerting them to the importance of securing their own financial independence—all are integral parts of the visioning work. If possible, it is also important for them to estimate the discretionary income needed to handle unexpected expenses unencumbered by the inheritance expectations of their heirs. For example, some parents want to help children (or grandchildren) with special needs—a divorced son or daughter who might be going through a rough patch in their lives; a disabled grandchild who requires special medical attention; or a relative who cannot afford adequate housing.

The financial costs associated with the retirement of the seniors and the successful transition to multi-generational enterprises is often underestimated (particularly in privately held enterprises). As the seniors contemplate their departure from the management and governance roles they have occupied, they quickly realize that their (and their family’s) lifestyle is often tightly intertwined with the economics of their business. The compensation they have drawn historically through salaries, bonuses and dividends typically does not reflect the income they will need in order to sustain the life to which they have grown accustomed—office space; secretarial assistance; access to professional help (lawyers, accountants and consultants) and staff to look after their personal affairs; a travel and entertainment budget; the protection of security guards; and the use of the corporate plane, to mention a few—are all hidden costs that need to be catalogued and quantified if adequate budgeting for the future is to occur. Similarly, formalising the governance structures and processes necessary to continue a complex multi-generational enterprise will also cost additional money. For example, bringing the family together regularly for meetings and retreats; compensating family members serving on newly formed committees of the emergent governance structure for their time and their travel costs; remunerating independent directors and trustees that may be hired; paying for professionals assisting with the transition (consultants, lawyers, financial planners and so on) need also to be appropriately estimated. Indeed, the viability of continuity often hinges on estimating adequate financing.

Occasionally, some seniors are also called upon to assist the businesses they turned over to their successors. In a family we worked with, the seniors had long retired when one of the sons acting arbitrarily (and in violation of the shareholders’ agreement) made decisions that seriously compromised the viability of the family enterprise. The parents were then asked by the banks to reinvest a significant portion of their savings in order to rescue the company and the family’s reputation. As the mother explained to us: “You think that once you retire you’re done. But you’re not. You simply can’t stand on the sidelines idly while the business you built for so many years takes a dive. Getting out of the cockpit is one thing; getting off the plane is quite another…” Also helping the seniors identify financial obligations they may have underwritten (such as collateralised loan guarantees) and working to articulate policies to protect them from downturns in the family’s fortune are all critical at this stage. Unless the seniors feel reassured that their interests have been protected, they are likely to resist transferring assets—and especially control over decisions—to the next generation.

Another fundamental task that falls on the seniors during the visioning stage of the ownership transfer process is that of defining the boundaries of the family as they pertain to access to financial information and the inheritance of risks, burdens, opportunities and assets. How these boundaries are drawn also has a profound impact on who is involved in what way with the planning process. Are all future shareholders willing and able to honour the access to financial information in a responsible and confidential manner? Who will be entitled to what share of the wealth and why? Are all children to be shareholders in companies owned by the family? If so, in what proportion will shares and voting right be allocated to whom? How will in-laws be treated? What about adopted and stepchildren? These decisions are not just pertinent to matters of inheritance; they also affect the participation of heirs in future governance roles. Under what conditions should children or in-laws serve as trustees or on business boards? Underlying many of these questions are assumptions about how the composition of the family will drive ownership expectations, rights and responsibilities.

Drawing these ‘entitlement’ boundaries is particularly thorny with regard to how in-laws will be treated. In some families when the children marry, their spouses are brought into the family as ‘full citizens’ and are thus treated exactly like blood descendants. So in these families, in-laws are given the same access to financial information and comparable opportunities to participate in the governance (or even the management) of the enterprise as their direct descendant spouses. In other families, in-laws are treated more like ‘resident aliens’: they are offered ‘voice’ but not ‘vote’; they have access to some (but not all) financial information; and their potential involvement with the family enterprise is more restricted. In these cases, the underlying assumption is that the in-laws can be trusted up to a point but not further. And, finally, there are families in which the in-laws are treated as visitors with ‘temporary visas’. In these families, in-laws are explicitly (and often unapologetically) excluded from any conversations regarding ownership and financial matters. The underlying assumption is that giving them access to information about the family’s wealth is risky and potentially harmful to both the family and the enterprise. Whereabouts a given family places its in-laws in this ‘continuum of trust’ is affected by many factors, including: the quality of marital relationships in the first generation; the family’s history with contentious divorce; the financial independence of the in-laws, as well as the family’s values and its religious and ethnic background. Clarifying these boundaries and reflecting on the consequences of drawing them in one way or another is a critical task during the visioning stage. Ultimately, the family must emerge from the visioning stage with a clear understanding of the implications of their choice, a narrative that explains why they have adopted the inclusion philosophy that they have and a plan to share the information with the relevant stakeholders and assure that legal agreements are drafted consistent with this choice (e.g., ownership structures, shareholders’ agreements, wills).

The visioning work with the junior generation (most of whom are typically the future owners) also poses its own set of challenges. For them the process of defining the future ownership structure can be both exhilarating and daunting. After many years of apprenticeship and deference, the experience of discussing ownership issues with the seniors can feel like the next stage in an evolving partnership with them. Over the years we have seen many cases in which groups of juniors, who were alienated from the family enterprise, enthusiastically embraced the planning process and invigorated the development of a new vision for the future. The challenge is often how to harness their energy to do this work while still keeping their expectations in alignment with what the seniors want and need from them. It is particularly important to clarify with the seniors how much influence they want to give their heirs to shape the ownership choices during the visioning process. Few things are more discouraging for the junior generation (and more destructive to family harmony) than when they engage in the visioning process thinking they have more authority to shape ownership decisions than their seniors are actually willing to give them. Unfortunately, it is quite common for seniors to squander the goodwill built during the visioning stage by going along with a more inclusive process only to yank authority back from the juniors and impose their own preferences at the crucial moment when decisions have to be formalised legally. Again, taking the time at the front end to clarify expectations about this is critical. There are basically, four ways decisions about the future ownership structure can be made:

  • the seniors retain all the authority and make the choices all on their own;
  • the seniors retain all decision-making authority but choose to consult with their children—sharing with them the relevant information and inviting their point of view and preferences into the mix of ideas that guide their choices;
  • the seniors choose to share their authority with their children and invite them into a joint decision process;and
  • the seniors delegate all of their authority to the juniors and have them make all the ownership decisions.

Both research on decision making[1] and our experience strongly suggest that either consultation (second bullet) or joint decision making (third bullet) are the most effective processes to use during the ownership transfer. This is particularly so when the family aspires to keep its enterprises and wealth as an interdependent portfolio owned collectively and governed through an integrated structure. There are two basic reasons why this is so. First, the successful implementation of ownership decisions often requires the involvement of those whose lives will be affected by them. If these stakeholders participate in the decision making process in some constructive way, they are more likely to own, accept and commit to the choices that are made. Secondly, even in close-knit families, the seniors often make the wrong assumptions about what the juniors may want for their future. By involving the juniors in the decision process, the possibility for open and direct communication is enhanced, often leading to choices that are better informed. The one potential drawback of a more participatory process, however, is that it takes time. Educating people to understand the issues, creating structured opportunities for them to reach consensus on the choices, helping them learn the interpersonal and communication skills necessary for effective negotiation, can all lengthen the transition period. This is why the sooner a family can motivate itself to engage in planning, the more options it will have for managing the transition process.

Learning how to collaborate effectively with their seniors is not the only challenge the juniors face during the visioning process—they must also learn to collaborate with each other. When a group of siblings and/or cousins meet for the first time to discuss their future and that of the family’s wealth and its enterprise, they quickly learn that they are quite diverse in their background and perspectives—some are older, others younger; some are daughters others sons; some feel like favorites others not; some have worked in the business for many years while others have pursued their studies and careers away; some are very successful and wealthy in their own right while others may be struggling economically and are still quite dependent of the parents; some have expertise that is relevant to the discussion of ownership issues while for others these issues are quite foreign and even intimidating. These differences notwithstanding, the juniors must learn to deal with each other in new ways. Indeed the visioning process offers the juniors an opportunity to shed biases, roles and stereotypes from childhood that may have lingered in their relationships and rediscover each other in an arena defined by a new set of issues.

There is an inevitable asymmetry of information and understanding about the family enterprise—its strategy and operations, its products, customers and suppliers and, especially, its economics and legalities—that builds over time between those who work more centrally in senior management roles and those who do not. Discussions about inheritance of stock and the future ownership structure make this gap evident. How those who have built careers in the family business will be treated in the future, with regard to stock allocations, is often a serious concern among the junior generation that emerges during the visioning process. It is not unusual for those who have devoted their careers to the family company to expect a larger share of stock than their siblings and cousins who have not contributed to building the enterprise. As the oldest son from a prominent Latin American business told us: “In our case my sister and I joined the company when our father was just starting out. We worked by his side since the start like partners, so why should we now be treated as equals to our brothers and sisters who weren’t involved at all?” The tendency for people who have worked in building something to overvalue the worth of their contribution, and hence the share of stock they deserve, is so common that Dan Ariely, a renowned behavioral economist from MIT, named it the “IKEA effect” (after the store whose customers must invest considerable effort in building its unassembled furniture products—and which presumably leads them to overvalue their purchases once these are assembled). In contrast, the juniors who were not involved with the company often take the position that those who worked in the family business were using the family’s shared equity as capital, that they received ample compensation as executives and that consequently they are not necessarily deserving of larger shares of stock in the future. As we have indicated, these conversations offer wonderful opportunities to contextualise expectations of entitlement and educate family members about the need for a governance architecture that helps regulate and institutionalize the relationship between those in the family, those who will be shareholders and those who are (or aspire to serve) in management roles.

 

4. FORMALISING: GETTING OWNERS TO DOCUMENT THE AGREEMENTS INTO LEGALLY BINDING CONTRACTS

Once a family emerges from the visioning work with a clear consensus on what it wants for the future, the next stage of the process requires transitioning from an ‘imagined possibility’ to a set of formal agreements that will add permanence to their vision. Some of these documents, such as the family constitution or the family business protocol, are morally binding, whereas trusts and shareholders’ agreements are contractual documents and hence are also legally binding.

What documents a given family chooses to legalise varies considerably depending on the family’s history, its culture of origin, the nature of the assets that are owned collectively and the jurisdiction in which the family operates. For example, families with a history of litigious shareholder battles (or acrimonious divorces) often draw more elaborate legally binding agreements; whereas families who have enjoyed a more harmonious relationship over generations frequently settle for more informal documents that are mostly morally binding. Similarly, families in common-law cultures tend to prefer agreements that articulate broad principles while being short on policies, whereas families from civil-law cultures tend to prefer elaborate documents that spell out many policies for dealing with a wide array of contingencies.

While our focus on this chapter in on the process through which families reach these agreements, it is useful to list kinds of issues that form the content of these formal documents. The figure on the following page attempts to organise the types of issues that these agreements cover into the three-circle model depicted.

Not all family agreements cover all of these areas. Typically, the issues that fall under ‘ownership’ are articulated in a shareholders’ agreement and are legally binding. (Sometimes these policies are woven into the articles of incorporation of the business, or built into the trust that holds the family’s controlling shares.) Some families in jurisdictions where there are no trusts go off-shore to formalise their agreements or look for local legal arrangements that serve to formalise their commitments. For example, we have worked with families create a legal ‘family association’ in order to legitimize the norms that they adopt in the family. Indeed, in some jurisdictions, such as Spain, the protocolo familiar has been legally sanctioned as a binding agreement among family shareholders that bridges the gap between the traditional wills used for stipulating inheritance and corporate shareholders’ agreements.

An essential step in formalizing these agreements is picking a good team of advisors. As the list of issues suggests, formalizing these agreements requires a multidisciplinary team, involving at least a lawyer with estate and corporate experience, a financial/wealth management expert, a business strategist and someone well versed in family business governance. While the issues are typically segmented in accordance with disciplinary boundaries, most are in fact interdependent—for example, whether a group of current and future owners want to stay together or not is often a function of the quality of the family relationships they have; financial planning for retirement is driven by the economic performance of the assets; leadership succession depends on business strategy and the family’s preferences; and so forth. These issues do not fall neatly into the domain of one or another profession.

As George Bernard Shaw once put it, “all professions are conspiracies against the laity”—they each have their methods, nomenclatures, ethical codes and fee structures. Creating a team of professionals, accustomed to working on their own, to assist a family in formalizing its vision is indispensable though seldom simple. This is particularly so with regard to ownership issues, in which professionals may feel more liable and vulnerable to errors of judgment. When the process is well managed, families pay careful attention to picking advisors who understand the interdisciplinary nature of these issues, are interested, and are willing and able to collaborate with colleagues from different backgrounds. Moreover, it is important for families, as the clients, to explicitly request integrated advice that examines the issues from a variety of perspectives. In addition, it is highly recommended to build into the process opportunities for the professionals to meet regularly in order to examine their assumptions, coordinate their strategies and think through the implications of formalizing the family’s vision across their respective disciplines. Emerging with an integrated approach can greatly expedite the process of formalizing a vision.

As families get closer and closer to formalizing and, especially, to legalizing their agreements, it is common for them to grow increasingly anxious about the formal commitments into which they are entering—issues that seemed resolved at an earlier juncture re-emerge even more forcefully, second thoughts and even regrets about concessions made on an issue earlier in the process are quite common, as are recriminations that the give-and-take among the family owners involved in the negotiation has not been fair or even-handed. It is important for the team of advisors to serve as ‘midwives’ of the formalizing process—upholding the values of the family; being empathic and staying open to new solutions that may have not been evident earlier on in the process but still, when appropriate, serve to provide an ‘institutional memory’ that reminds everyone of the reasons why they chose their original positions; nudging the process along without pushing or imposing their own views on the issues; and, above all, remaining impartial and focused on the interests of all.

This is not an easy mandate to fulfil. Professionals often become the lightning rods that absorb the owners’ frustrations with the wear and tear associated with any protracted negotiation. The professionals are at their best when they, as Nelson Mandela put it, “lead from behind” while still managing to give their clients and each other support. The final signing of ownership agreements constitutes an important milestone in the history of any family business and deserves to be noted and celebrated. When the process is well managed, it concludes the formalizing phase with a signing ritual that marks the beginning of a new era in the life of the family.

 

5. IMPLEMENTING: GETTING THE OWNERS TO TURN AGREEMENTS ON PAPER INTO LIVING ORGANISATIONS

While the formalizing of agreements certainly brings an important phase of the ownership transfer process to a close, it is important to keep in mind that agreements (even legal ones) on paper are often not followed through in practice. For example, many families agree to set up independent boards of directors to oversee their businesses and holdings, but then fail to recruit the external directors to serve on them. Following exhaustive negotiations, some owners agree on elaborate voting policies to manage decision making among shareholders or at the board, but then continue relying on the old guard to decide for them. Others endlessly negotiate policies to regulate the involvement of family members with governance and management roles, but then fail to operationalise them effectively. The truth is that old habits are hard to change: committees designed to oversee the implementation of policies take too much time and can be ultimately neglected; and individuals charged with certain responsibilities do not follow through or resist being held accountable.

Families and the professionals who serve them must be attentive to the fact that translating agreements into functioning organizations is one of the most difficult (and frequently neglected) challenges underlying the orderly transfer of ownership.

It is often useful to pick a transition committee staffed with individuals with the authority and leadership skills necessary to oversee the implementation of the ownership agreement. It is important for this committee to have a clear mandate and be formally given the authority it needs to make decisions on behalf of the owners to implement the agreement. Mapping out the critical tasks, seeking the appropriate professional assistance, budgeting the financial resources necessary, establishing a timetable for implementation, developing a user friendly version of the agreements to serve the purpose of communicating, educating, and supporting the task of implementing—all are essential. Also, it is important to build into the implementation process quarterly meetings with the owners in which they can be kept abreast of the process and provide oversight to the committee’s progress. These meetings are also opportunities to foster transparency and hold those charged with implementing the ownership agreement accountable.

One of the most difficult tasks facing a transition committee during the implementation stage is populating the emergent structure that grows out of the agreements. It is important to recognise that while an open inclusive process is generally more conducive to collaborative problem solving, not everyone needs to be involved with everything. It is, therefore, useful to differentiate the family owners into three basic categories:

  • The make-it-happen group—composed of the people who absolutely have to be involved with the implementation effort if it is going to work. Because they have both the power to make the critical decisions and access to all the relevant information, these people form the core constituency for the ownership transfer and their support is essential for the plan to be implemented.
  • The let-it-happen group—these are the people who have the power to derail the process and need to be sufficiently involved as to feel that they understand and can bless the choices and decisions that are being made on their behalf, but they do not need to be the drivers of the process.
  • The watch-it-happen group—these people need to be kept informed periodically about how the implementation process is unfolding. Their views should be heard and put into the mix of implementation opinions. However, they are more marginal to the process.

Organising the implementation process requires paying careful attention to who gets involved with what elements of the work at particular junctures.

Finally, as suggested at the outset, no ownership agreement lasts forever, even if flawlessly drafted and implemented. The fundamental driver of change in families is the biological clock—the same individuals will have very different needs, wants and aspirations at different junctures of their lives. Adopting a developmental mindset and recognising that every agreement is but a temporary equilibrium that, with luck, buys the system some years of stability is in our estimation essential. The further in time the ownership agreement gets from the people who forged it, the higher the likelihood that a new agreement will need to be renegotiated. This is so because the psychological ownership that grows from having participated in the forging of the ownership agreement cannot adequately be transferred to subsequent generations. At some point down the line they will need to roll up their sleeves and get their own hands dirty with the process of drafting a new compact to guide their economic and familial interests. As Goethe so eloquently put it: “What you’ve inherited…you must earn to possess.” ▪

 

Ivan Lansberg, Ph.D. is a co-founder of Lansberg • Gersick a research and consulting firm in New Haven, Connecticut, that serves family businesses, family offices and family foundations. Ivan was previously on the faculty of the Yale School of Management, and is currently on the faculty of Kellogg School of Management at Northwestern University. He is an advisor to business families worldwide, a frequent presenter at conferences, and the author of many articles and publications, including Succeeding Generations (1999, Harvard Business School Press).

Maria Dolores Moreno is a family business advisor and a frequent collaborator and Senior Associate with Lansberg Gersick, a consulting firm in New Haven, Connecticut serving family businesses, family offices, and family foundations worldwide.

Source: Globe Business Publishing, May 2009

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      (1)  Vroom, V and Yetton, P, Leadership and Decision-making. Pittsburgh (1973) University of Pittsburgh Press.