One of the greatest rewards of building a family business is bringing the next generation into the fold. In general, family members instinctively understand the legacy and mission of such a closely held business and are committed to carrying on those ideals.
But there are also risks. If a family business is to grow and thrive—for customers, for workers and for investors, most if not all of whom are family members—the right people need to be in leadership positions. That makes the task of hiring all the more important and prompts a simple question: how does a family business make sure that family members end up in the right jobs to ensure the success of the business?
A common scenario
Consider a hypothetical example. ABC Corporation, a family-owned consumer products company, was formed 40 years ago by the father of the current management team. The father grew the business from $100,000 of annual revenue to more than $300 million in his 20-year stint at the top. When he stepped down, his three children took over the leadership of the company.
The second generation learned a lot from the father. All were effective leaders and believed in the company’s mission. But during their 20-year leadership tenure, the company grew to $450 million—a respectable business, to be sure, but not the kind of growth the father had overseen. And with another generation in position to enter the business, a question emerged: Will the company be able to support the nine family members in the next generation?
This story is all too common. As the family grows, the business does not grow by the same factors. Without proper planning, the family may decide that it is easier to sell the business outright and avoid the risk of cannibalizing the business while trying to support the next generation. But there is another option. With proper governance and planning, a business can survive a transition and become even more vibrant under new leadership.
Preparing the next generation
We have found three common threads among family businesses that successfully transition between generations:
- Requirement to work outside the business:
Gaining outside experience can provide many benefits to the business. Having this requirement often grows out of a concern that family won’t be able to provide the coaching and feedback that is necessary for the next generation to reach its potential. Another deciding factor is often that the family doesn’t want the next generation to feel compelled to work in the business. When this is done correctly, it can allow the business to flourish through opening new markets or shifting focus.
Consider two examples. One developer and contractor that used such a policy ended up with a transformed company, thanks to a member of the second generation who applied outside experience to the family business. The first generation had focused on single- and multifamily housing as well as smaller construction management jobs. The second-generation family member moved away and worked for a much larger contractor for a period of time. The experience allowed the company to enter the larger commercial market, nearly doubling profitability in a short period of time.
Another situation involved a food manufacturer that was focused on one product for nearly two generations. One of the family members in the third generation took a sales position with a large public company. Working his way up to management, the family member decided to move back home and become chief executive of the family business. While chief executive, the person focused the company on three goals: research new uses for the company’s core product, drive better margins through efficiency and technology, and drive sales through customer relationships. This focus allowed the company to increase its value 20 times during the third-generation chief executive’s tenure with the help of both family and nonfamily members.
- Require family members to interview
Recently a new chief executive of a family business asked me how I would define her job. “Your No. 1 goal should be to increase shareholder value,” I replied. As self-evident as this seems, it’s not always clear in a family business. Goals as a family member or parent are often in competition with the goals as a chief executive or senior executive. In practical terms, this may mean not offering a job to your son or daughter who isn’t qualified. But as a parent you want to see your children well employed and the family business may be where you want them.
To help executives and family members navigate these emotionally charged situations, it is important provide “emotional cover” for the correct business decision that might be at odds with family dynamics.
This cover can often be provided through the formation of a family interview committee. The committee is responsible for hiring, firing and promotion decisions related to members of the business owner’s family. The committee format can provide cover for the person who would usually be in charge of hiring decisions, as well as an objective decision-making body that will take family dynamics into account, but will make decisions based upon the merits of the individual and best interests of the business.
To be most effective, such a family interview committee should be composed of both family and nonfamily members. The committee is responsible for search, interview and decision-making with respect to any position where a family member is involved. This means that if a family member could potentially fill the position the committee would be responsible for interviewing the family member and any outside applicants to make an informed decision. It is also important that the decisions of the committee are shared with the outside as group decisions and that one member doesn’t outwardly disagree with those decisions.
- Memorialization of policies and guidelines
Implementing these policies is often not popular and can be complex. Take the earlier example of ABC Corporation: After the number of family members in the business has increased from three to nine, gaining consensus and moving the process forward could be difficult if not impossible. But if the precedent is set by the three current members of leadership, it is more likely to reach a point of engrained policy.
This process of putting certain policies and guidelines in place—also known as memorialization—is just the first step. The family must also understand how these policies are intended to protect the business and the family. Without this step, generations will often lose the vision and foresight of past generations. The policies and guidelines will then fail and with them the protections they afforded.
To avoid generational failure, we often recommend annual shareholder and family meetings. These meetings must go beyond financial results; they must create an arena in which all the interested parties can discuss the vision of the company and how the family interacts with the company. The intent is to build a family culture that the business is both an investment and a part of the family.