In my work with sibling or cousin shareholder groups, I often encounter unprepared, or “sudden” shareholders. These individuals come into ownership of their family’s business as a result of a gift or the death of a parent with little to no preparation for the role of owner. As these shareholder groups come together to align for the future, a challenge they face is that some of the shareholders who now have decision-making powers have not been equipped with the knowledge on how to effectively manage this responsibility.
Often the “sudden” shareholder becomes dazed and confused about what being a shareholder means. Questions like: “What are my responsibilities?”; “How much time do I have to commit?”; “Do I have to do real work if I am a shareholder?” “What if I really don’t want to be an owner – what are my options?” arise in their minds. They don’t really understand what ownership of the family business means to them or the broader family.
This situation can bog down the governance process and lead to ineffective decisions as the shareholder group seeks a threshold level of knowledge to “get up to speed.” In addition to the time each individual shareholder may need to wrap their mind around their rights and responsibilities, the group of shareholders also has to learn to collaborate as a team of owners – something that doesn’t just happen by virtue of kinship! The governance process tends to slow to the pace of the family shareholder with the least knowledge.
A critical component of multi-generational family business continuity is a cohesive shareholder group. The better prepared the family is for transition of ownership from one generation to the next the smoother the transition will go. A key part is preparation of all potential next generation shareholders through a deliberate next generation shareholder development effort. By learning about being an effective shareholder well in advance of a triggering event, the family and the business will be better equipped for continuity and will not run into the unnecessary burden of power without knowledge.
When the family business has shareholders with diverse financial needs and interests, disagreements over distribution policies can be challenging to the business and the family. To better manage these discussions, it may be helpful to know or consider the following:
Estimate the financial needs of the business utilizing both strategic and operational business planning.
Determine the shareholders’ risk tolerance –are they willing to utilize leverage to finance future needs o the company? The current environment for obtaining outside capital should be taken into account.
Determine shareholder attitudes regarding desired ownership percentages into the future. Are they willing to take on outside investors?
In situations where shareholders are taxed personally for business profits, allow for tax related distributions at the highest tax level applicable.
Set a base annual living expense distribution that the business should be able to accommodate without endangering its ability to compete.
Based on best estimates from the business planning process, estimate the capital needs of the business over the next 3 to 5 years.
Establish a distribution formula based on the needs of the business and risk environment of the business. Some businesses have relative low risk levels as a result of stable markets, strong customer base or niche products or services not easily challenged or duplicated. Potentially higher business volatility will generally demand a higher level of reinvested earnings and a lower level of shareholder distributions in excess of tax and baseline distributions.
Remember these issues are not static, it is important to review shareholder concerns on liquidity and risk on at least an annual basis. Discuss with the board potential implications of the answer to these questions on the existing distribution policy and capital needs of the business. This also underscores why it is critical that management of the company establish and review strategic initiatives with the board on a regular basis, and that the board consider the impact of those initiatives on shareholder objectives. Finally, shareholders need to revisit their objectives and distribution expectations in light of the strategic opportunities identified for the business.
Ram Charan has some good advice in his book “Boards That Deliver.” In it he lists what the top subjects of focus should be for effective boards. Not surprising to many of us, the number one priority he identifies is: “Do you have the right CEO…”
In public and private companies, boards are too often lax in their responsibility of reviewing, evaluating and developing management at the top. Whether a family member or not, all boards should ask if the company’s leader is the best suited person for the job – bearing in mind the company’s current needs and strategic direction. If the answer is “no,” the board must look to make a change and shareholders should support the process.
When the business is family owned and managed, the most difficult leadership change decision comes when the CEO who needs replacing is a family member. Truly independent directors are critical to help all stakeholders navigate this challenge. While these directors must be wise in their judgment of the business’ needs, in order to really be effective in this delicate situation, they are ideally well known to the family and respected by all, as well as experienced with family business and sensitive to the concerns and needs of the family, in addition to those of the business. This awareness will not lead them to change their mind about what is best for the company – but will enable them to interact with the family, and communicate the needed changes in a manner that all stakeholders feel respected, which will help the family remain united, despite this needed business change at the helm.
This is a follow-up to the October issue of the Family Business Advisor, which presents the non-strategic value of directors. We are often so focused on finding “the best” director candidates, that not a lot of thought is given to the circumstances under which they will find our family business attractive. How do we appeal to outstanding directors?
The list can be very lengthy, but there are a number of questions we often get from the candidates we try to recruit – some food for thought:
Is there currently a functioning board in place?
Are there other independent directors, or would I be the only one?
Does the family really want outside advice or are they just attempting to appease a group of shareholders?
Have they developed specific expectations for this position?
How would you describe the communication within the family (collaborative, conflictive, for example)?
Does the business have a strategic plan?
How would you describe the leadership style of the current Chair? The current CEO?
Remember that board candidates are interviewing you and your business as well. They want to commit to a board that works well together, knows how to be productive, and presents a culture that is aligned with their own values and business principles. So getting your ducks in a row prior to your search is a good way to send the right message to great candidates!