THE FIVE SECRETS OF ENDURING BUSINESS FAMILIES
Article | April 2015 | by Peter Creaghan
Many of our clients started with very little, worked very hard, saved and invested most of what they earned. Along the way, they ended up building wonderful organizations that now employ thousands of Canadian workers and taxpayers. The loss of any one of these wonderful organizations not only hurts the family owners, it hurts all of us. On the flip side, when they stay together and continue to grow, like, say, McCain Foods or Power Corp. are doing (both of whom recently lost founders), then we all win.
WHAT'S AT STAKE: THE RULE OF 72
Consider for a moment what’s at stake here. We know all too well about the terrible family price that gets paid when a business breaks down: that’s the part that hits the newspapers and gossip wires. But sometimes dollars and cents can be a simpler way to measure, so let's look at the financial value in this equation.
The Rule of 72 is a simple rule that helps quickly calculate the doubling period of an investment. In our context, it helps us understand what’s at stake financially with a successful family business. How does this rule work? Simple, divide the rate of growth you expect on your investment (say 7%) into the number 72 (which gives us 10). Ten is the number of years that it will take to double the value of your investment at a 7% growth rate.
In most cases, a typical family business will have historical returns well north of 7%. At a 10% growth rate, for example, a business value will double in the next 7 years. So, a business that is worth $100m now, and growing at 10%, will be worth $200m in 2021. This means that all you’ve accomplished (at least financially), over the entire history of the business, will happen again over the next 7 years. And then again over the 7 years following that. Think about it! Is it worth preserving for the future? Of course it is!
Then why does it happen so seldom. Why are McCain Foods and Power Corp. the exceptions rather than the rule?
THE UNIQUE CHALLENGE: HOW TO BUILD A BRIDGE
The unique challenge with family-owned businesses is... the families that own them! Families don’t always cooperate. Indeed, there’s a lot more at stake inside the average family that just money. There are powerful egos, jealousies, and trust issues. There are differences in risk tolerance, business philosophies, and management styles. There are family members who are intensely interested in business, some who are indifferent, and some who find their passions in completely different areas.
And yet, this diverse group called a family finds itself thrust together through their common ownership of a successful business. And, for the sake of their common future, they need to find a way to become coordinated, responsible, capable owners if not managers of their businesses.
How can we make that happen? How can we create the environment in which coordinated, responsible, capable owners can flourish?
Each and every one of us comes from a family, with it’s own unique characteristics. We all tend to think “my family can’t be changed; it is what it is.” In my opinion, that’s absolutely correct. But guess what? We don’t need to change the family, or anyone in the family. What we really need to focus on is the space between the family and the business, what goes on in the relationship between these two entities. It’s the relationship that matters, because in every case, the family and the business will be unique. So how do we construct a productive relationship between the family and the business, a relationship that will protect and enhance both.
So we can all breathe a bit of a sigh of relief on this topic. There’s no need to worry about changing either the business or the family: let’s worry instead about how to build a bridge between the two.
THE FIVE KEY INGREDIENTS TO THE BRIDGE
There are five key ingredients, in my opinion, to this “bridge”as we’re calling it. These five ingredients are like the “critical dials” in an airplane cockpit. Have you ever seen the gauges, dials and switches inside an airplane cockpit? To an average passenger, a panel of flight instruments may seem like a totally confusing smorgasbord of information. To an experienced pilot, however, there are a handful of dials that are critical. And these are the dials that a pilot will pay most attention to.
In the same way, for business families, there a a handful of “critical dials” to manage. As with airplane dials, they’re never precisely where you want them to be, and they need continuous attention and adjustment as the journey progresses. Here are the “critical dials”:
1. INDEPENDENT ADVICE
Independent advice (and the key word here is “independent”) is the cornerstone of any business family success. All too often, controlling owners will rely on their company’s CEO or CFO, or their long time accountants, lawyers, bankers, etc. All have a historically-based interest in supporting the controlling owner’s views. As Albert Einstein once noted, “No problem can be solved from the same level of consciousness that created it.” Or as we like to put it: you can’t read the label from inside the bottle.
Because of this, it’s imperative that family owners find a way to reach outside the bottle for solutions. As one of our clients said to me recently, “we thought our issues were private, and we thought we could solve them as a family group with our longtime key advisors, but we didn’t really make any progress at all until we made the difficult step of reaching outside for help.” Ultimately, independent advice will take the form of a fully-functioning board of directors, composed of family members, key advisors, and strong, knowledgeable, independent outsiders. An important first step on this journey is to find at least one strong, experienced, and independent advisor to start the process.
2. FUTURE OWNERSHIP PLAN
The first thing that a strong, experienced, and independent advisor will want to know about is your future ownership plan. In essence, for most of us, that will be most clearly captured in our estate plans. The largest asset (by far) in the estates of most business owners is their investment in their businesses. By handling the question of what happens when I die, a business owner is also handling the question of who will own the business after me.
An ownership continuity plan will address the following questions: Who will own the business in the future? How will ownership be transferred? When will ownership be transferred? In most cases, for tax and other related reasons, ownership transfer occurs gradually and episodically over the years, not really by design but primarily to avoid unnecessary taxes. Estate freezes and trusts are often put in place, for example, to defer taxes to the next generation. Other companies and assets are also put into next generation ownership structures. Most often, control is maintained for a good deal longer by the original owners. Full and complete ownership transfer occurs only with the death of a controlling owner.
To be successful, your future ownership plan needs to be put down on paper, it needs to be examined, alternatives need to be explored, and ultimately the plan needs to shared with all potential family owners. This is difficult terrain for most of us to talk about, and virtually impossible without independent advice. We have a client who started a very successful automotive parts company, with several thousand employees. The founder had three children, two very capable and a third with a severe learning disability. When we first met with the longtime company accountant, the client’s key estate and tax advisor, we asked whether he knew what the plan was for the learning-disabled child. Would the company be left one third to each child? And, if so, how would that work? The accountant replied, somewhat shocked, that had never asked the question. He presumed it was none of his business ask such a personal question.
3. FAMILY CLARITY
As the future ownership plan gets clarified, ideally in co-design discussions with the potential future owners, we will need to establish clarity within the family about what they own, how much it’s worth, where are we heading as a family and a business, and what happens when someone exits. We call this set of standards and agreements called The Family Rule Book (one of our clients calls it their Family Bible!). When it’s finally written down, it acts like a guidebook for how we behave as a family of owners.
The Family Rule Book can address a host of questions and concerns inside the family, including: What is our vision for the business? What is our current ownership structure? What is the business value and how do we calculate that? How do decisions get made? How will we be compensated as owners? How do we handle exits from ownership? With our “Family Bible” client, for example, it became clear once the Bible was in place that the spouses of the founding brothers did not want to own or depend upon ownership in the business as a source of income after the brothers died. They each felt it was inappropriate for them to exercise undue influence over a business in which they had little involvement or knowledge. Moreover, they didn’t want to interfere with the business plans of their adult children who were running the business. A solution was developed to buy out the shares they received from their husbands and leave the ownership and management of the business to the next generation.
4. FAMILY FUNDING
Family funding requirements, like in the example above, are one of the most overlooked ingredients of the bridge. Probably because so few families understand clearly their future ownership plan, they also don’t understand the inherent costs of that plan. Even less understand where the money will come from to handle those costs. Most families end up paying far more than they need to because they are forced to use assets on hand to deal with their family cash needs. Planning ahead can dramatically reduce those costs.
A Family Funding Plan will address the following questions: How much money will we need for family needs (estate taxes, dividends to the family, retirement, charitable contributions, buyout of inactive owners, etc.) When will we need the money, precisely? What assets will be sold/leveraged to raise the cash needed?
Recently we worked with a real estate based client named Joe who was told by his tax advisor that his estate tax bill would be $75m. When the client appeared shocked, the advisor replied, “tell me, Joe, what’s the difference really if your kids get only $225m instead of $300m?” Let’s face it, there’s some truth to that question. Does anyone really “need” $300m instead of $225m? But the conversation became much more interesting when we tied to decide which assets would be sold to cover the $75m tax bill. Like most businesses we’ve worked with, there were no “redundant” assets lying around. The client had a very well-designed portfolio of properties, all serving a purpose in the overall business mix. He didn’t want to have to sell anything!
5. TRUST AND COLLABORATION
Trust is the magic ingredient that makes all the others work, and at the same time is a result of doing all the others well. That may sound circular, and it is. But let me repeat, trust is both a result of the work, and a necessary ingredient to start the work. The less the trust, the harder the work. The more the trust, the easier the work. Can trust be learned? You bet. Most of us communicate in ways that reduce trust, without even knowing.
A classic example that occurs in families all the time is the “co-tell” instead of “co-design” approach. Co-tell works like this: “Son, this is how our future ownership plan will work.” Co-design works like this: “Son, I’ve been thinking about how we should plan for the future ownership of our business, and here are my thoughts. What are your thoughts on the matter? How do you see it?” The first is very short, but has aftereffects which ripple underground into the future like a seismic shock. The second conversation takes a great deal longer, has many more twists and turns, but builds a fabric of trust along the way.
Most families haven’t really budgeted for the time or resources they need to communicate effectively. One client we work with decided to start family board meetings, but had no way of getting information of any kind to the family members attending. No agenda, no consolidated financial statements, no meeting facilitator, no real plan at all. No one really knew why they were there… and you can guess what happened! One of those present later referred to the meeting as a “goat rodeo.” It takes a lot of work to communicate properly. It takes preparation, and the resources to prepare properly. It's progress, not perfection.
THE FAMILY CAPITAL COMPANY
Each of these five key ingredients needs to be attended to all the time, as the business changes and as the family changes. Working these ingredients into the daily operation of your businesses and families becomes like a separate business unto itself, what we call your Family Capital Company. Your Family Capital Company will protect both your business and your family, and ensure a bigger future for both.