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Who is the family business client?

1 January 04

Writer's view that answering this critical but complex question is central to resolving a family business's succession issues

by Ken McCracken

One answer to the question is any of the family businesses that represent 75% of all registered companies in the UK. Various studies in different parts of the world have identified the family controlled business as the most common form of business entity, ranging from well-known global companies to the smallest start-up, which is often supported by family capital instead of external finance. Family businesses are likely to represent a significant part of the client base of many advisers, but despite this they remain a largely unrecognised sector of the economy.

Lack of recognition stems partly from the practice of categorising businesses in many useful ways – for example, by reference to size, structure or sector – but not by reference to what they are, a family in business together. There is still a tendency to view family influence as a threat to business success, which leads to the common view that the best approach is to leave the family out of the business and to treat the family business client like any other business. This article questions whether this is the right approach.

A typical scenario

Tom is the managing director and owner of a second-generation family business that was started by his late father. Tom’s brother never entered the business and his father’s decision to leave all the shares to Tom resulted in a rift between the two brothers that has never been resolved.

Tom and his wife Mary have three children. The youngest, David, joined the business straight from school, while his siblings Susan and John pursued careers elsewhere and started their own families.

Tom thinks he would like to retire, but he feels financially vulnerable because over the years he has re-invested a lot in the business. In addition to looking after their own financial needs and worrying about how Tom will spend his time after he retires, Tom and Mary are concerned about how best to equalise their children’s inheritance. A friend has suggested to Tom that “obviously” all the shares should go to David because he works in the business. However, Tom does not want to cause a family split as happened with his brother. Tom and Mary would far prefer to divide the shares equally among their children (equal being the same as fair?). In any case, maybe Susan and John will one day come home and work in the business, an outcome that Tom and Mary subtly promote at every family get-together.

To complicate matters further, Tom is excited by a new business opportunity that will require fresh investment, but in Tom’s opinion, which he has not told anyone, David is not experienced enough to drive the business forward on his own. However, Tom knows he is not getting any younger, a view recently confirmed by his doctor who recommended that Tom should take things a bit easier. Tom decided not to share this advice with Mary because it would worry her.

Technical solutions should wait

Tom’s overall aim is to balance the needs of his family and the business and leave as his legacy the foundations for a successful family business. Faced with this complex series of interlinked problems the adviser should be aware of certain risks. The first is the understandable urge to bring order to the complexity by reinterpreting Tom’s case as a series of technical issues to which there are good technical answers.

Everyone perceives, understands and interprets the world through a set of paradigms (S Covey, “The 7 Habits of Highly Effective People”, Simon & Schuster UK, pages 23-29). The adviser’s technical expertise represents a complex paradigm, one way of interpreting the world. While the adviser will undoubtedly feel better if the debate can be moved on to the more comfortable ground of the adviser’s expertise, it is very unlikely that at the outset Tom’s concerns can be reduced to a series of discrete technical problems.

The “expert” paradigm can also lead to the problem of premature evaluation. Reframing Tom’s needs as a series of technical problems that can be answered swiftly seems contrary to the aim of exploring how to create structures that will help this family business to thrive for at least another generation. For Tom and his family the question “What are the options for the next stage of the family business?” precedes the task of implementing solutions with technical proficiency. Finding an answer is likely to be a long-term project rather than something that can be resolved quickly.

These risks should especially be kept in mind if the adviser’s firm, following the emerging model of legal business, has chosen to do only certain types of work, for example private client or corporate work. If Tom’s aim is to balance the needs of his family with the family business, can the necessary advisory work be categorised in this way?

Coming to terms with the issues

An alternative approach would be to seek a new paradigm to help Tom and the adviser to interpret what is happening. Tom and his family are experiencing major changes in their lives. They have realised that the organisation of the business will have to change, especially if the shares are divided among three siblings some of whom might not work in the business. Tom and his family need to spend time exploring new structures for their business and coming to terms with the new roles and responsibilities that they will each have in the future. An (incomplete) list of issues that need addressed would include the following.

  • How can Tom and Mary harvest money from the business to fund the next phase of their lives? This involves a combination of personal financial planning and business planning with a view to achieving a balance between their financial needs and what the business can afford, taking into account the investment needed to exploit the new business opportunity.
  • What does “retirement” mean to Tom, and does the rest of the family agree with Tom’s opinion? Does Tom want to walk away from the business completely or does he want to retain “an interest”? Does he need to stay involved to help build up his retirement fund as well as to give the business the benefit of his vast experience?
  • Depending on what Tom does, how will David feel? Does David want to assume control from his father, or would he like dad to remain involved in the business? Does the family need to come to terms with bringing in “outsiders” because the needs of the business now outstrip the competencies of the family?
  • Will outsiders really understand the values of this family – thrift, hard work and a desire to build a successful multi-generational enterprise? Will they be prepared to work within a structure that places these family values at the heart of the business?
  • In future what will the owners do, especially if Susan and John inherit shares and resist their parents’ far from subtle encouragement to come home and join the business?
  • What rights and responsibilities does this family attach to ownership? Is it a means of maximising return for the existing owners or will they see themselves as custodians for the next generation of the family?
  • Do David, Susan and John want to be in business together at all?

While Tom and his family will no doubt need access to technical expertise in due course, they first of all need to explore many different options for their futures and to test the viability of each of these. Every family business is unique because every family is different and the challenges facing Tom’s family cannot easily be made to fit neatly into the specialist expertise of their technical advisers. If the advisers want to help Tom and his family tackle these issues, there is a need to discover new models and approaches.

These new paradigms are being developed in the fast growing international field of family business knowledge and practice. Inevitably new ideas challenge the conventional approaches of every profession; for example, how do we respond to the question “Who is the family business client”?

Is it Tom as the managing director, or as owner, or the person who happens to be both of these things and, at the same time, husband, father and grandfather and someone who is worrying about his health and what he is going to do after he has stopped devoting so much of his energy to his passion – the business? Or, since any decision about the future will affect Tom’s whole family, is it not reasonable to argue that they are included as clients, not forgetting, of course, the business itself?

Conflict, and conflict of interest

The idea of the client being the whole family business system – family, owners and business – might feel uncomfortable for lawyers who are rightly concerned that acting for this number of people might involve conflicts of interest. In one sense of the word, conflict is inherent in every family business, but just because it is inevitable, does that necessarily mean that it must represent a conflict of interest for the adviser?

Take for example how David might feel if he eventually wrests management control from his father, but ownership control lies with John and Susan who together own two-thirds of the shares, though neither of them works in the business? It would not be at all surprising if anyone in David’s position felt that his efforts were unfairly benefiting his siblings, who qualified for ownership simply through birth. However, if the family collectively still wants to pursue their dream of a successful multi-generational business, is it helpful if each of the siblings appoints separate advisers whose perspective (or paradigm) is to do the “best” for their client, whatever effect this might have on the family’s dream of a future in business together?

Alternatively, client service could extend to helping the entire family explore the structures of organised accountability among sibling owners that have been developed by many successful companies. This often includes designing into the governance structure mediation processes to cope with the inevitability of conflict.

If the lawyer and the client (in the wider sense) agree that the engagement is to help the system cope with a fundamental transition in ownership and leadership of the business and in the roles of individual family members, and everyone who is participating in the project is advised that they can at any time take independent professional advice, is there a problem of conflict of interest?

An interdisciplinary field

Providing effective help to family businesses requires advisers from different professions of origin to collaborate in exploring new paradigms and new methods of helping their clients. Advising family businesses and business families is a truly interdisciplinary activity. What family businesses need is a range of expertise provided by advisers who can understand what happens in a family business system that is undergoing seismic changes. The aim of the advisers should be to pass on their skills and knowledge to the client so that the clients can better understand their family business and take decisions based on their unique circumstances. When they have taken these decisions, then it is time to engage technical advisers to test the feasibility of the client’s choices and plan for tax-efficient implementation.

Regardless of their size, economic activity or geographical location, family businesses will face the same generic issues when it comes to navigating a transition in ownership and leadership between generations. Family businesses face these challenges by virtue of the simple fact that they are a family in business together. It is simply impossible to leave the family out of the family business. Ask Rupert Murdoch.

Ken McCracken is a consultant with Family Business Solutions Ltd and a partner in the Family Business Group at Wright, Johnston & Mackenzie, Solicitors. He can be contacted on 0141 222 2820 or kmc@wjm.co.uk