Family Business Enterprise Forum Notes

Three columns presented consecutively by the Family Business Enterprise, Massachusetts Mutual Life Insurance Company, D195, 1295 State Street, Springfield, Massachusetts 01111-0001, USA.

In this era of multinational corporations and borderless economies, the family business is popularly perceived to be a relic of the Nineteenth Century. In fact, there are 12 million family-controlled businesses currently providing 59 percent of total US employment and generating 78 percent of net new jobs. As the Fortune 500^® corporations are being re-engineered and downsized, new opportunities are being seized by smaller family businesses further enhancing their profitability and value. Family-controlled businesses power today’s economy.

A recent survey (September 1995) undertaken by the Family Business Network of the Massachusetts Mutual Life Insurance Company (MassMutual) offers some unexpected insights into today’s family businesses. The 1,029 respondents to this Gallup Organization survey spanned from the oldest continually-owned family business dating from 1800 (now in its eighth generation of family ownership) through 37 percent founded prior to 1960 to half of these businesses still being in the first generation of family ownership.

Encouragingly, family-owned businesses are openly planning for the succession of ownership and management, and working consciously to keep the business within the family. This increasing trend now finds 44 percent of family-owned businesses have a formalized (written) succession plan for transition of ownership and management control. Predictably, older owners are more likely to have implemented a formal succession plan; 63 percent of family business owners over the age of 65 have a written plan in contrast with only 38 percent of owners under the age of 50. About half of the men have a written succession plan in contrast with about one-third of the women family business owners. Perhaps surprisingly, there is little difference to be found between older and young family businesses or between large and smaller family businesses in having established formal succession plans.

Focusing on the challenges of succession, it is understandable that family business owners are more concerned about the negative impact of estate taxes than they are about capital gains taxes. With estate taxes rising to 55 percent and higher, 28 percent of these business owners report their primary concern is estate taxes in contrast to only 14 percent whose primary concern is the capital gains tax. With 63 percent of the respondents reporting that the business represents more than half of their family’s net worth, this anxiety simply recognizes that estate tax bills can compel the family to liquidate their assets by selling the business, selling stock, or increasing their business debt.

Consequently, family business owners are becoming more aware of the extent of their estates’ tax liabilities and are undertaking more definitive estate planning. Fifty-eight percent of family business owners now report having a "good" idea of the estate’s tax liability; this level of concern seems to be consistent across all sizes of businesses with 55 percent of owners of businesses with annual revenues under $10.0 million offering the same response. While some form of life insurance is the most popular vehicle through which heirs are expected to pay estate taxes (66 percent), the use of cash reserves (13 percent), trusts, liquidation, buy-sell agreements, cash, or investments are alternative or supplemental resources by which these tax bills are to be paid.

This preoccupation with estate tax liabilities has caused 26 percent of family businesses to purposefully reduce the capital investments in these enterprises. Thus, more than a quarter of all family businesses are being either downsized or exposed to greater risk in response to these anticipated estate tax liabilities -- a worrisome issue of public policy.

Looking at today’s ongoing operations, family businesses are more sanguine about their access to capital than has been reported in earlier surveys. More than half (54 percent) of family business owners find their access to capital to be "excellent." Improved access to capital appears to be particularly striking among smaller businesses -- i.e., annual revenues less than $10.0 million -- with 51 percent now finding their access to capital to be "excellent." And there is little difference between men and women family business owners. Almost half of all family businesses (48 percent) have personal guarantees or loans to their companies; this increases to 51 percent for the smaller family businesses. However, more than two-thirds of those making personal guarantees or loans say they are either "not at all concerned" (42 percent) or "not too concerned" (26 percent); only 8 percent report being "very concerned." Nearly one-third (30 percent) note that 75 percent or more of their family’s net worth is invested in the family business, and another one-third explain that between 50 and 74 percent of their family’s net worth is invested in the family business.

Continuing our summation of the Gallup survey of family-controlled businesses undertaken by the Family Business Network of the Massachusetts Mutual Life Insurance Company (MassMutual), it is first noted that more women are found in senior management positions in family enterprises across the US than are to be found in non-family businesses. However, only 16 percent affirm that a daughter is involved in the business as opposed to one-third (34 percent) reporting a son’s involvement. Brothers are engaged in 26 percent of these businesses as opposed to only 11 percent involvement by sisters. And fathers are involved in 21 percent of family businesses in contrast with mothers’ involvement in only 11 percent.

Almost three-quarters of fathers (73 percent) and brothers (72 percent) and more than half of sons (56 percent) are identified as part of the key decision-making group within these family businesses. This contrasts sharply with about one-third of mothers (28 percent), sisters (37 percent), and daughters (30 percent). And sons are four times as likely to be identified by the present owners as controlling ownership and governance decisions in the next genera-tion (34 percent versus 8 percent). Similar gender patterns are found in the ownership of equity, and in the assumption of management responsibilities. Significantly, almost equal representation is to be found on the boards of directors of the family business; fathers and mothers (79 percent versus 78 percent), and sisters and brothers (59 percent versus 64 percent). However, while gender-based discrepancies are pronounced, the family business sector still holds greater promise than non-family businesses for an ascendant role for women.

Two-thirds of the persons owning family businesses (67 percent) grew up in families that owned a business (not necessarily the current family business), one-third (35 percent) were reared in families that have owned businesses for two generations, and one-fifth (23 percent) have been raised in families that have owned businesses for three generations. This kind of social learning is believed to play a key role in the cultivation of future business owners.

Three-quarters of all family business owners with children emphasize they encourage their progeny to follow in their footsteps; they either "strongly" (26 percent) or "somewhat strongly" (46 percent) encourage their offspring’s participation. The principal motivation to encourage their children to be part of the family business is the conviction that it offers a "good business opportunity." These findings suggest entrepreneurship is likely to be instilled at home at an early age; growing up in a family business appears to foster entrepreneurial activity.

The dynamics of decision-making in the family enterprise are mixed. Decisions on strategic issues are usually made by a small number of key leaders who reach their decisions through a process of consensus. More than two-thirds of the respondents (68 percent) believe the members of the key decision-making group "always" trust each other. However, only 43 percent of these family business owners believe the members of the decision-making group always share common goals and objectives, and only 35 percent believe they place the needs of the business over their own considerations. And only 17 percent of the respondents find that the members of the key decision-making group always achieve what they set out to accomplish.

Decisions about the company’s strategic direction, capital investment, and other major issues are made by only one or two individuals in 37 percent of the businesses surveyed. Three decision makers are found in 24 percent of these firms, and four decision makers are found in 18 percent of these firms. And almost half of the respondents (48 percent) relate that differences are resolved most often by discussing the issue and reaching a consensus; the strategic team tends to be more autocratic than democratic. Finally, the primary goals of these family businesses are to enhance profitability as well as the value of the enterprise. Increasing profitability was ranked by the respondents as either "among the most important" (32 percent) or a "very important" (57 percent) goal. Similarly, increasing the value of their enterprise is ranked either "among the most important" (25 percent) or a "very important" (54 percent) goal. Less than half of the family business owners find expanding the size of the business (46 percent) or providing liquidity for the shareholders (42 percent) to be "among the most important" or "very important" goals.

With the average tenure of a CEO of four years in a non-family business, the family business enjoys a different growth horizon where the average tenure of a CEO is 24 years. The family business can seek solid improvement over the longer term, in contrast with the public demand for improvement in quarterly intervals. The owners and managers of the family business can focus on increasing value and profitability, not on growth merely for growth’s sake.

Upon completing the Gallup survey of family-controlled businesses undertaken by the Family Business Network of the Massachusetts Mutual Life Insurance Company (MassMutual), an analysis of the composition and structure of the key decision-making groups revealed substantial variations in the way family businesses are managed and directed. The key decision makers had been identified as the "... group of individuals who make key decisions for your firm. These are the individuals who make decisions on the company’s strategic direction, capital investment, hiring and firing of key personnel, and other major steps." This analysis examined the participation of family members in relation to the owners or co-owners along with the number of non-family members participating in decision making. Employing the statistical technique of cluster analysis, this data yields pictures of seven distinct types of family businesses.

Cluster 1: "Parental Oversight" (13 percent of family firms) The manager and co-owner of these businesses is relatively young (average age is 37) and the firms are in transition from one generation to another. Virtually all of these firms are second or third generation; the older generation has relinquished its primary responsibilities, but retains some equity and exercises some oversight. At least one parent and frequently both parents participate in the key decision-making group, with non-family member involvement absent in half the cases. Intergenerational disagreements over capital investment and the strategic direction of the business are more numerous than usual, with only 30 percent of the key decision-making groups reportedly "always" sharing common goals versus 43 percent overall.

Cluster 2: "Looking Ahead" (16 percent of family firms) Owners of these firms have their children involved in the business; while 90 percent intend to pass on ownership to the family, they have not yet relinquished control. Trust strongly spans the generations within these businesses with 76 percent reporting the members of the groups "always" trust each other. In contrast with the Parental Oversight cluster, conflicts among generations over the strategic direction and future of the business has not yet emerged; decisions are reached by consensus (59 percent).

Cluster 3: "Dominant Owner" (12 percent of family firms) The owner is king (89 percent) or queen (11 percent). These are primarily first-generation businesses (59 percent), and are smaller than average; more than half (55 percent) have annual revenues of less than $5.0 million. This is the least likely of all clusters to have a board of directors (65 percent); with no non-family or strong family representation, its function is largely perfunctory.

Cluster 4: "Outside Assistance" (33 percent of family firms) The owner/manager in these companies makes key decisions without much family involvement, but places critical reliance upon a small number of non-family members. In a minority of these firms, the group encompasses a co-generational peer, e.g., a sibling (23 percent), sibling-in-law (10 percent) or extended family member (5 percent). The size of the typical decision-making group is small (the mean is 3.1), smaller than any cluster other than the Dominant Owners, but a majority of these firms (71 percent) have between one and three non-family members in this group.

Cluster 5: "Mom and Pop" (17 percent of family firms) A spousal pair dominates these businesses; many women owners or co-owners have companies conforming with this pattern. The key decision-making is not necessarily limited to the marital pair, with a child participating in one-quarter of the firms; typically, one (39 percent) or two (19 percent) non-family members also participate.

Cluster 6: "The Mega Firm" (4 percent of family firms) Not surprisingly, these are the larger family businesses with an average of 347 full-time employees, five times greater than the average for all firms in the survey. An average of ten people participate in the decision-making group in these companies in contrast with the other clusters with three or four individuals. Non-family members are always involved and four or more participate in the majority of these companies (56 percent), with an average of four outside advisors.

Cluster 7: "The Sibling Team" (6 percent of family firms) Ownership is shared with at least one and usually two siblings in these companies, with a parent also involved in the key decision-making group in 35 percent of the cases. However, no non-family members are involved in 52 percent of these companies, and only one outsider participates with the siblings in 28 percent of these companies. Decisions are reached by consensus in three out of five of these firms; this is the cluster most likely to report that the goals of the business "always" come before individual concerns (43 percent).

Where does your family business fit in this analysis?

Facts and Figures

Continuing our summation of the American Family Business Survey 1995 sponsored by the Arthur Andersen Center for Family Business (Arthur Andersen & Co., SC), let us now examine some of the highlights of this informative study.

The majority of these family-controlled businesses have been formed since World War II with more than one-third of the leaders being 61 years of age or older. More than one-third of these leaders expect to continue playing a role in their businesses by never retiring (11 percent) or through semi-retirement (23 percent). Dilemmas in successor selection are apparent inasmuch as 40 percent of these withdrawing leaders have not designated a successor. Significantly, 42 percent suggest that co-CEOs are possible in the next generation.

More than half (51 percent) of these family businesses have a strategic plan in place. But interestingly, full details of their strategic plans are not shared with company management in 35 percent of these cases. Without the involvement and buy-in of management, execution of these plans is likely to be difficult. Virtually all (91 percent) expect their business to remain in the hands of the family over the next five years, and more than half (53 percent) restrict ownership through buy/sell agreements.

About 40 percent of these family businesses schedule periodic professional valuations of the company stock. The most common single method of valuation, book value, is cited by 30 percent of the respondents, although it may be the least satisfactory indicator of realistic market value.

These family-controlled businesses report increasing sales revenues; they are optimistic this growth will continue. A substantial majority (79 percent) have recorded increased revenues during the past five years. Since 1990, annual revenue growth of greater than 10 percent is reported by 30 percent of these companies, and growth rates of more than 20 percent is reported by 12 percent. The larger businesses report more rapid growth and anticipate a higher rate of growth. Significantly, the results of this survey reveal that growth is correlated with a more active board of directors, more family members in the business, having a strategic plan, and greater emphasis upon information technology and international markets. Although the majority of respondents (69 percent) have a purely domestic focus, about 8 percent of respondents do 11 to 50 percent of their business internationally; only 1 percent generate more than half of their revenues abroad.

Over the next five years, annual revenue increases of 6 percent or greater are foreseen by nearly two-thirds of these companies (66 percent). And a clear majority of these businesses (64 percent) expect to be enhancing employment over these next five years.

Identifying their toughest challenges, a near-majority (48 percent) predictably point to increasing competition. Further frequently-named challenges and frustrations include government regulations (40 percent), labor costs (31 percent) and a lack of qualified employees (29 percent). Corporate and/or personal income tax regulations are perceived to be the most onerous government burden (68 percent); other aggravating burdens include the environmental codes (49 percent) and regulations of the Occupational Safety and Health Agency (46 percent).

Best Practices

In conclusion, correlating the results of this survey, patterns emerge for the family-controlled businesses whose success can be measured by long-term survival, expanding revenues, and strong growth. These best practices encompass:

Strategic planning: These plans must be communicated throughout the organization. Strategic planning is highly correlated with better estate and succession planning, and with stronger revenue increases.
Active boards of directors: Active and independent boards are positively correlated with strategic planning and strong revenue growth.
Continuing education: Almost 28 percent of respondents participate in continuing education centered on family businesses; they are likely to have greater awareness of succession, estate tax, and other business-continuity issues.
Keep equity within the family: Almost 63 percent of family businesses restrict transfers of share ownership to preclude alien or hostile shareholders. A majority (53 percent) have buy/sell agree-ments and 40 percent confine ownership to family members actively employed in the business.
Trusted business advisors: The most trusted business advisor by family business leaders is their accountant (44 percent); lawyers are the most trusted business advisor by 19 percent of these family businesses.

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These last two columns have been based upon research conducted and published by the Arthur Andersen Center for Family Business (Arthur Andersen & Co., SC),711 Louisiana (Suite 1300), Houston, Texas 77002.

Family Business Traits

The family business is as American as apple pie and the Fourth of July parade. Ford, duPont, McDonnell-Douglas, and W.R. Grace are only a few of the family businesses that are among today's corporate giants. And there are thousands of fine mid-size and smaller family-controlled businesses delivering respected services and products all across the United States.

The family business has many unique strengths and advantages. Family members literally grow-up in the business from childhood. The business is the topic of discussion over the dinner table each night or at Uncle David's family dinners every Sunday evening. Family members are usually the beneficiaries of tough on-the-job training in the business from early adolescence as well as superb academic educations. Family members are willing to sacrifice for the good of the business in ways that would be inconceivable in a corporate position. Family members have a sense of loyalty and commitment to the business that is unknown in today's corporate environment. Family members may have a powerful sense of mission and noblesse oblige far surpassing what is found in the public corporation.

But today we know that few families anywhere fit the mold of the Brady Bunch. Almost every family has tensions, jealousies, and internecine rivalries. A dominating patriarch -- or matriarch -- may impose apparent conformity for a brief period, but this may only suppress the boiling turmoil and divisions within the family. Being expected to "go into the family business" is now more commonly seen as a curse than a blessing. Too often, the family business simply exacerbates the stresses skulking behind the facade of unanimity and contentment. Contemporary biography would have us believe that America's great corporate founding families were virtually all dysfunctional families.

Tips and Tricks

Here are some of the guidelines that have helped to assure the long-term success of the family business.

Make your mistakes elsewhere. Some families have the rigid rule that the heirs-apparent must first work 5 to 10 years with another business -- frequently a large corporation in the same industry -- and achieve some notable successes in this job before joining the family business. Upon then coming on board, they are recognized to be a competent and valued player in the industry, not just "the boss' son or daughter."

Only competence counts. Family members are entitled to a job in the family business only if their performance is equal to and preferably clearly superior to the unrelated employee in a parallel job. The family must hold itself to the highest standards of performance; they must be mentors to all other employees. Lazy and mediocre relatives are resented by non-family employees at all levels and quickly become a malignancy within the organization. Some families pay the incompetent relative to work at some other job simply to keep his/her debilitating influence out of the family business.

Key non-family positions. The family business must make a conscious effort to place a number of non-family members in key management positions. While it is clear that the CEO job is unlikely to be available to them, they must be given real responsibility, authority and power, and must command the respect of the family. The right people for these critical jobs will expect a generous compensation package and often some kind of equity-equivalents. In the 1920s, the duPonts began giving their non-family executives "phantom stock" which became a most effective incentive.

Plan for succession. Succession is one of the touchiest problems in most family businesses. Two rules are fundamental. First, plan early, and in an orderly and open way. This vital decision should never be deferred until after the death or unanticipated disability of the founder or CEO; only bitterness and misunderstanding are likely to ensue. And second, the selection of the successor should be entrusted to a truly independent and knowledgeable outsider. This outsider must know the company and have observed the candidates at work. This outsider may be a professor who has been a long-term advisor to the company, or possibly an independent CPA or an attorney. Obviously, it is essential that this outsider have "no axe to grind" and that the ultimate decision can be expected to be one fully respected and honored by both the family and the key non-family workers in the company.

The family business is unlike all other forms of business ownership. It has remarkable strengths and advantages, but it can also unleash some disastrous demons. These guidelines offer the basic weapons to protect the prosperity of the carefully nurtured family enterprise from the demons lurking within the family itself.

Generation to Generation By Kelin E. Gersick, John A. Davis, Marion McCollom Hampton and Ivan Lansberg

Between 65 and 80 percent of all businesses worldwide are owned or controlled by families, including 40 percent of the Fortune 500^® corporations. In the United States, family businesses employ more than half of our workforce and generate more than half of our gross domestic product (GDP). Indeed, family-controlled businesses are the dominant form of business throughout much of the world. Family businesses are truly very big business.

Generation to Generation: Life Cycles of the Family Business is an analysis of the way in which the family-controlled business differs fundamentally from the public corporation. The four authors are seasoned management consultants whose focus has been family-controlled business enterprises. Out of their unavoidably practical work coupled with their academic research has emerged the development model of the family business presented in this book.

The model of the public corporation encompasses two dimensions or axes -- the business axis and the ownership axis. The goals, expectations and demands of these two axes are frequently in tension; continually resolving these tensions in constructive ways is the job of the senior executive.

The model of the family-controlled enterprise embodies three dimensions or axes -- the business axis, the ownership axis and the family axis. Even in the healthiest organization, there are inevitable tensions between the goals, expectations and demands of these three axes. The authors explore the family business along these three axes: the business over time (from Start-up, to Expansion/Formalization, and Maturity), ownership over time (Controlling Owner Companies, Sibling Partnerships, and Cousin Consortiums), and the family over time (from the Young Business Family, to Entering the Business, to Working Together, and Passing the Baton).

"[f]amily businesses draw special strength from the shared history, identity, and common language of families. When key managers are relatives, their traditions, values, and priorities spring from a common source. ... However, this same intimacy can also work against the professionalism of executive behavior. ... Roles in the family and in the business can become confused. ... When they are working poorly, families can create levels of tension, anger, confusion, and despair that can destroy good businesses and healthy families amazingly quickly."

The substance of this investigation cannot be portrayed accurately by simply extracting a few snappy aphorisms. However, a primary conclusion is that a robust business rarely springs from an unhealthy family. The business cannot be used to "solve" or mask family problems. The senior executives in the family business must be able to confront the request to employ or promote an unqualified family member, to make an ill-advised payout or dividend distribution, or to embark upon an imprudent strategy. Nurturing one’s family is as important as working resolutely within the business enterprise.

A significant suggestion is the formal establishment and use of a family council. This enables business matters affecting them to be discussed openly with non-participating members of the family. The family council also helps to define the boundary between the family and the business. It offers the structure to create a shared vision and a "code of understanding" -- a family plan. The family business introduces an added dimension of communication -- both ways -- within a family. If a family cannot communicate openly and effectively, the family business exacerbates a situation that is already unhealthy. The first priority and greatest challenge to the senior executives in the enterprise is to foster a vigorous family.

The authors examine the issues of leadership, organizational structure, strategy, organizational behavior and financial management that are unique within the family business enterprise. The issues of bringing family members into the firm, promotions, and planning for succession are explored carefully. This work concludes with two pithy lessons:

Lesson 1: Treat the Business Like a Business, the Family Like a Family, and Ownership with Respect; and
Lesson 2: Keep in Mind the Inevitable, Constant Nature of Developmental Change.

This development model of the family enterprise is grounded in reality with all its richness and diversity. It offers anyone working with or connected with a family-controlled business vivid insights into the special dynamics and challenges they confront moving through their life cycles.

Myths

One of the most comprehensive and statistically valid analyses of US family businesses is the American Family Business Survey 1995 sponsored by the Arthur Andersen Center for Family Business (Arthur Andersen & Co., SC). It was conducted jointly with the Family Enterprise Center at Kennesaw State College and the Loyola University Chicago Family Business Center. With the participation of 3,860 family businesses, these enterprises have median annual sales of $9.5 million, 50 full-time employees, and have been in business an average of 43 years. This survey discredits four common myths about family businesses.

Myth No. 1: Family business is synonymous with small business.

"Unlike the popular image of family businesses as simple mom-and-pop enterprises, business leaders responding to this survey are likely to take a sophisticated and disciplined approach to managing their substantial businesses. Only 2 percent of the nearly 4000 respondents have annual sales revenues below $1 million, 44 percent have annual revenues of $10 million or more, and slightly more than a fifth report revenues exceeding $25 million annually.

"Significant percentages of these family businesses engage in strategic planning, actively use boards of directors, embrace advanced technology and take advantage of family business education programs."

Myth No. 2: Family and non-family employees are in different classes when it comes to compensation.

"Family businesses use various compensation practices in roughly equal proportions for family and non-family executives. As the most common provision, 65.5 percent of companies have annual cash-bonus policies for non-family, and 65.9 percent for family. The arrangements are also almost identical for long-term bonus policies and compensation contracts.

"Among the exceptions is a bias for more disability protection for family, with 27 percent of companies offering it to family members and 21 percent to non-family. Family members also have more salary-continuation contracts, a policy of 12 percent of the companies, as compared to 6 percent of companies with such provisions for non-family members.

"In terms of compensation arrangements, nepotism does not seem to be prospering in family businesses."

Myth No. 3: Family businesses are afraid of new technology and hesitate to invest in new ways of doing business.

"Family businesses take new technology very seriously. Nearly two-thirds rate investment in information technology as ‘very important’ or ‘important’ for achieving future goals. Another 24 percent view it as ‘somewhat important,’ while only 10 percent consider it ‘not important.’

"More than 67 percent of respondents say information technology has enabled them to improve customer service, 62 percent to enhance productivity, 53 percent to boost responsiveness, 44 percent to influence competitive advantage and 42 percent to develop quality control."

Myth No 4: Families plunder their businesses to serve family needs.

"When dividends are paid, they are tied to corporate dividend-paying ability and not usually to family-member needs. In C corporations which represent 55 percent of the companies surveyed, 32 percent pay dividends. The most common determinants of dividend payout are profits, used by 54 percent of companies, and company cash flow, 18 percent. A quarter base payout on constant payments and only 3 percent cite family member needs as the determining factor.

"Among S corporations, comprising 41 percent of the sample, 92 percent make distributions to owners. The most common determinant is to cover taxes, used by 53 percent of companies. Next is profits, used by 46 percent of businesses, and company cash flow, used by 33 percent. Family-member need is a determinant in 15 percent of the cases, with constant payment used in 5 percent of companies. In general, business issues come first, although there is slightly greater bias toward meeting the needs of family members in S corporations than in C corporations."

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