Ownership, Inheritance, Succession And Control In Family Businesses

Starting-up and getting a business to stabilize and start paying off, is one sort of challenge.At the time,an entrepreneur might even be glad to have family and relatives  pitch in and give them a helping hand.

Its only a little later that a whole lot of other challenges crop up.People who bear risk ,put their own life and priorities on hold or put in substantial efforts into a business expect that their contributions will be rewarded,not just perhaps in the form of a one-time or limited pay-out but in terms of a share of future profits and control over the business,so that they can guarantee and determine the quantum and timing of payouts.Perhaps even these challenges could be managed by having open discussions with all concerned ,ensuring full buy-in and clearly recording what is owed to who and why.

However,if the business has to be passed down in the family,there is no way of avoiding the discussions on ownership, inheritance, succession and control.

Parents usually want all their children to inherit equally and, besides, often the biggest assets are wrapped up in the business. But the next question often is whether the children actually have the skills to run the business,whether they have an interest in running it and whether they can work well as a team.In case the potential heirs can’t answer yes to each of these three questions a few other challenges predictably follow :Those actively engaged in the business resent those that they see as free-loaders ,ie. family members entitled to equal  shares of the business and distribution of profits, even though they are uninterested or unqualified to work in the business. The free-loaders tend to see the owners working in the business as robbers who have inveigled cushy salaries and benefits.Arguments about compensation and profit distribution become inevitable.

As a work-around to this problem of some owners feuding with their owner-manager relatives, families can develop a means for deciding who gets to be the owner-successor that is perceived to be fair.This simple model that replicates the role of the founder,in that it keeps ownership and control in one person (or couple) can be successful for many generations. Think of the British monarchy. Or Caterpillar Inc., whose corporate philosophy encourages distributors worldwide to have one person who works in the business with ownership control.

Alternatively,if a family has siblings who work well as a team, with each person contributing more or less equally,the partnership model works well. All owners work in the business and benefit financially from it.Examples would be traditional family businesses,inherited from the father and run by all brothers as a partnership. These partnerships work as long as the brothers contribute more or less equally to the business’s success and draw the same salaries and profit distributions.However,trouble is likely to break out in the next generation if all the siblings don’t have the same number of children,or there is wide difference in the ability or willingness of the children to contribute to the business or if some of the brothers have a child whose succession is unacceptable to their siblings,say,perhaps on account of their gender,as these days plenty of daughters want to take an active part in the running of family businesses.

Thus, in either the second or third generation families might have to adopt a distributed model where ownership is passed down to most or all descendants, whether or not they work in the business and  staffing and compensation policies would have to be agreed upon to decide which family members get to work in the business and in what capacity and how and how much they are to be rewarded for contributing to the success of the business.

Another option available to family-business owners to accommodate varying talents and interests is to opt for the the nested model where various family branches agree to own some assets jointly and others separately. This model ,nested in the sense that smaller family ownership groups sit inside larger ones , is particularly attractive when conflict or differences in preferences interfere with decision-making on shared assets. For the nested model to work, the family runs the core business as a profit-making operation and distributes relatively large dividends to the branches, which then use this money to create their own business portfolios. The nested model can effectively reduce tension among branches while keeping the family together as a whole. There’s a risk, however, of under-funding the core business to finance the outside investments.

However, if the question of who runs the core business becomes a sticking point,a final option is the public model, where at least a portion of the shares are publicly traded, or where a family business behaves like a public company even though it remains privately held. Whether shares are publicly traded, or not, the business is run by professional managers, and the owners play a minimal role, usually limited to electing board members. Otherwise, they either support the direction of management or sell their shares. This model works well when the business requires a significant infusion of outside capital, or when owners are too numerous, dispersed, or disinterested to be engaged actively in decision-making. The key question then becomes how the family owners can maintain control when they play such a limited role in making decisions about the business.

So,there are five different ways of owning family businesses: 1.) owner-manager, 2.)partnership, 3.)distributed, 4.)nested, and 5.)public. However,in reality most family businesses are hybrids though they may largely correspond to one of five models of ownership. One of the most important decisions family businesses ever make is to choose which model to adopt.Understanding each model’s implications and trade-offs  allows owners to start having calm discussions about ownership,inheritance,succession and control and make compromise possible.

It’s critical to periodically revisit how a family business is structured, particularly during times of transition. Holding on to the model that worked beautifully in the previous generation can threaten, or even kill, the business in the next generation. It can also put an impossible strain on family relationships.There is also no natural progression from the owner-operator model to the public model. Owners can, and do, move back and forth between models. Ownership groups have shifted even very large companies from the public model to the distributed model. Of course, moving to a different ownership model involves big changes in governance, legal structures, and family relationships. That’s not easy. But adopting a new ownership model can help owners unlock a family business that’s become very stuck. It may also be the one thing that can keep your family together.