The family business is one of the economic staples in the American economy.  While the family business category may not represent a majority of the revenue generated in the world of sheds, it likely does represent the majority of companies.  My article in the previous edition discussed achieving clarity in the three spheres of family business (ownership, leadership and family) and emphasized how essential this is to their long-term health and success.

In this article I want to particularly address the first-generation family business, where commonly one or two family members are the founders and still retain leadership and control over the business.  I’ve seen many family businesses where some sort of assumption is in place about who the successor will be, based on family or cultural norms. In many cultures, the oldest son is assumed to be the one to carry on the family farm or family business. This particular tradition no longer holds as much weight in many families, and even if it is assumed by the parents, it likely needs some sort of clarification for the family  as a whole. Not all “oldest sons” are actually qualified to carry on the family business—and in some cases, they simply aren’t interested in doing so.

Getting clear answers to the following five questions will be essential to a successful future for the company.  Let’s take these questions one at a time.

1. Who can be an owner of the family business? This question needs to be addressed with clarity before the time when specific people are involved in the discussion. While the business is relatively small, ownership may well reside with one individual family member even in following generations. If the company grows to the extent that a majority of the family’s assets are in the business, this can present unique challenges to family estate planning. In addition, a larger company cannot easily be transferred without negatively impacting those family members who do not get an ownership stake in the family business.

The first generational transition in family business is often quite simple: one or two family members buy out the founding family members, who then retire on the proceeds. If the company continues to grow, by the third generation there can be several different families and multiple generations now assuming some level of ownership opportunity.  What are the ownership parameters now? Will ownership be open to immediate family only, or also to in-laws? To key employees? To a capital investor? Families must lay out these criteria well in advance in order to achieve and maintain family harmony. They cannot be left to individual assumptions.

2. Who gets a job in the family business?  Some families assume that each child has equal opportunity to hold a job in the family business. In these cases, jobs are sometimes created to suit the individual—whether or not it is in the best interest of the company, and whether or not the family member is the best possible fit for the role. When family is in ownership and leadership, they have certain privileges in these areas. However, as the business grows and family members begin holding positions that report to other leaders in the business, these positions can quickly lack the kind of accountability essential to running an efficient and culturally vibrant business. If some positions in the business are held “by right of being family” and others are held by fit and performance, these diverse expectations quickly become opportunities for favoritism and nepotism to surface.  Company culture erodes quite rapidly, and with it goes performance.

Clear criteria for employees is essential both to growing a healthy company and maintaining healthy and harmonious family relationships. Sometimes families will be willing to invest in the education and training of family members to qualify them to fill key roles in the family business. Other families will expect the family members to forge their own way and prove their skills and competence by working in another company long enough to demonstrate they are qualified to do so in the family business. Again, clarity about what is required to get and keep a job is essential.

3. Who leads the family business?  Founder-led businesses are common. Many founders have a level of both financial and emotional “ownership” in the company  that makes it difficult for them to let go and hand off the leadership to the next generation. Occasionally you’ll see cases where the founder tires of the role and suddenly “dumps it off” to someone else; or he dies in the role with no previous plan prepared for transition, again “dumping it off” to unprepared heirs. These transitions do not serve the family or the business well.

Many advisors recommend that a leadership transition plan be put in place and unfold over a five- to ten-year period. This requires a lot of thought and conversation, along with some careful strategic planning, but it will lead to a much healthier transition. Sometimes this will require finding leadership from outside the family or ownership circle. Whatever the case may be, engaging all concerned parties in preparing a plan will help to diminish uncertainties and allow for adequate preparation and training. This is most successful when done with trusted advisors to help facilitate the necessary conversations.

4. How does our business serve the family’s values and goals? Every family has certain values and goals that informed the founding of a family business, and they do well to be intentional about regularly reviewing and reevaluating those values and goals. All the family members deserve to know what these are and how they impact the decisions being made in the business.

It is rare for a first-generation family business to have great clarity between family and business. Because of their close involvement and almost complete investment in the business, they may see its benefits as belonging to individual family members in whatever ways they personally choose: a source of cash for hobbies and personal investments, tools and equipment accessible rent-free for personal projects, business employees available to help family members with personal and family needs, and a host of other perspectives. As the business grows, these values and goals need to be clarified and often reframed. If this process is not undertaken and communicated clearly, there is often a growing diversity of expectations that brings unhealthy tension within both the business and family. Will the growth of the business itself become a part of the family legacy, or will each of us build our own lives independently of the business? What purpose does the business serve in our family?

5. What is the plan for the business profits? Again, this question becomes more pertinent as the company grows, building equity beyond the market-level salaries being taken home by employees. When a business approaches a generational transition, this question can quickly become critical. Founders and older owners often limit future growth, preferring to take equity out of the business to fund their personal goals and needs. Younger owners naturally tend to take a longer view of the business, preferring to leave as much equity in the business as possible in order to fuel growth and innovation.

In addition, a large percentage of business founders have not built any substantial wealth outside of the business itself and are depending on the business to fund their retirement years. This means cash must come from somewhere. The cash generation burden is often transferred onto the next generation as equity must be taken out of the business to buy out the current owners.

This challenge is one that can best be addressed by an advance plan for transition of ownership and leadership. Providing adequate liquidity for owners as they retire requires time and planning. Preparing for the next generation to buy into a company without unduly straining the company financially is also best served by preparing a strategic plan.

Giving adequate and timely attention to these five questions can help to set up your family business for success into the next generation. Don’t leave it to the estate plan or some crisis in the future that forces a hasty decision. Engage the issues with thought and clarity to help achieve business success and family harmony.