One of the most important issues facing family businesses is how to handle the next generation. They are clearly different from other employees whose wealth and reputation are at stake as current or potential owners of the company. Conversely, most parents are understandably worried that providing too many unearned benefits will not only undermine the next generation’s work ethic, but also the company’s ethos. In answering, families often choose one extreme: give the next generation special treatment that does not hold them accountable to the same standards as other employees (the “inheritance model”), or Demanding that you earn everything you get (the “merit model”). This article blends both elements and describes a path that is far more likely to lead your family to success.
“Some people live their lives thinking they were born at third base and hit a triple.” Often attributed to NFL football coach Barry Switzer, the quote is what many people think of the family business. I have captured that perfectly. Families are given jobs, promotions and salaries that they never would have been able to achieve without their name on their doorstep. A non-family executive said, “He is his COO of the company and the owner’s child.”
One of the most important issues facing family businesses is how to handle the next generation. They are clearly different from other employees whose wealth and reputation are at stake as current or potential owners of the company. Conversely, most parents are understandably worried that providing too many unearned benefits will not only undermine the next generation’s work ethic, but also the company’s ethos. In answering, families often choose one extreme: give the next generation special treatment that does not hold them accountable to the same standards as other employees (the “inheritance model”), or Demanding that you earn everything you get (the “merit model”). In my experience, a path that blends both elements is far more likely to lead to a successful family.
Risk of Inheritance or Merit
When roles are given rather than earned, it often creates an attitude of entitlement. ” When families exercise their privileges in this way, the repercussions for the company are devastating. Even more subtle signs of entitlement, such as being late for work or taking extended vacations to exotic locations, undermine corporate culture.
In light of these dangers, it can be tempting to remove the inheritance role from the company altogether, giving families not only the job but even ownership of the company. While this benefit model may seem attractive, it also carries real risks. Putting families against each other in a sort of talent horse race can create flanks within an organization, and in some cases even divide an organization. This led to the Dassler brothers splitting their company, Sportfarbrik Gebrüder Dassler (Geda for Geda for short), into his two competing companies, Adidas and Puma.
By forcing ownership on family members, you may feel compelled to work for the company even if it doesn’t suit you. These “gold handcuffs” can have detrimental effects on both the individual and the wider company because they are dissatisfied with being there. may need to divert resources from growth investments to fund acquisitions of own shares.
strike the right balance
So, at its extreme, neither the inheritance model nor the merit model are viable. A successful family business requires both elements. There are three main actions you can take to find the right balance.
1. Distinguish between rewards and dividends.
This line is often blurred in family businesses. Families can receive money that reflects both their day-to-day work responsibilities (compensation) and company stock (dividends). In many cases, this jumble is caused by tax savings. A family-run company pays everything as a reward because, due to the structure of the company, he is taxed twice on dividends. Another family business is the opposite: salaries are very low, but dividends are high due to the relatively favorable tax system. Another factor in this blurring of boundaries is the drive for equality under the premise that it is fair to treat everyone the same. Family members are often given the same amount regardless of their role or whether they actually work for the company.
If the family contributions are about the same, there is no problem. Calculate a reasonable amount to pay your family for work and investment capital, and distribute that amount in the most tax-efficient way possible. However, this level of symmetry is rare in generations 1 or 2 and beyond. Business competence and passion are much more likely to be uneven among family members. In situations like this, a one-size-fits-all approach can lead to resentment (“I’m doing more, so why should I do the same?”) and entitlement (“We are both Owns 50% of the assets of the “company, why should she get more?”).
The best way to address these issues is to develop separate systems for calculating what families receive in rewards and dividends. Compensation should be merit-based and should reflect the market value of the roles performed. Some families pay slightly above market rates to encourage their families to work in the business. Others pay slightly less to discourage them. But the core principle stands. A person serving as CFO is more valuable to the company than a new sales rep. Their compensation should reflect this reality.
Another reality is that company owners deserve some return on their investment. You are in gold handcuffs when the only way to make a financial profit from a business is to work there. It can mean paying a fixed amount each year, a percentage of shares or earnings, or whatever is left over after you have paid your bills and funded any necessary reinvestments. It should be based on the “inheritance” model. If we were cousins and owned equally in my parents’ shares, if you were an only child and I had two siblings with him, you would receive three times his share of the dividend pool. Distinguishing between rewards and dividends is essential to finding a balance between merit and inheritance.
2. Clarify decision-making by management from decision-making accompanying ownership.
In a family business, two brothers took over leadership from their father who founded the company. They made all decisions by consensus, from operations to strategy. Employees learned simple rules for getting buy-in to their demands, big and small. This approach worked because they were both deeply involved in all aspects of the business.
Looking ahead to the next generation, it became clear that a different approach was needed. Of her seven children combined, three worked in business and four did not (not planning to attend). 7 Not only does the decision by one person seem daunting, but how can people who don’t work for the company make informed choices about hiring employees or changing prices? If the people who had been in the stock making all the decisions, how was it fair to the people who collectively owned more than half of the stock? should give. But not in a way that would bring the company to a standstill.
The way out of this dilemma was to distinguish between merit and decisions arising from the inheritance model. The brothers made a list of every decision they’ve made regarding the company. Then sort them into her three categories: 2) decisions to be made by the owner (e.g. dividend payments); 3) Decisions when management should make a recommendation but the owner must approve or reject it (eg making an acquisition). Taking the time to develop this “Decision and Authority Matrix” has helped the next generation find the right balance between merit and inheritance.
3. Create a family culture that recognizes the importance of both active involvement and passive ownership.
There is a tendency to glorify the role of the “wealth creator” in the family business. At one of his seminars of mine, the clan CEO raised his hand and asked a question. Sure, it’s an understandable question. But that flaw became apparent when he was asked: He said that next he should take one of three actions. Borrow large amounts of money from the bank. Divert foreseeable future company profits to finance acquisitions. Or take on other equity partners who are far more demanding than his brother. None of these options were quite appealing, so he realized that his brothers were bringing something of value to the table.
The value of passive stock holdings is one of the most underappreciated contributions to the family business. Growing through retained earnings is one of the surest paths to long-term success. Especially when compared to high borrowing rates and equity partners who require exits to recoup their investments. As long as the demands of shareholders who do not work in the business are reasonable and their actions are not too distracting, it is a tremendous benefit to keep their money in the company. If someone manages it well and leaves most of their money invested without looking long term, there should be more than enough money to come around. Please value both of these levers of contribution. Passive shareholders should appreciate the hard work of the people working for the company (and reward them financially through market-based rewards). And the people who work for the company need to show investors respect in their communications (and generate good dividends).
Extreme versions of nepotism and meritocracy doom most family businesses. Instead, it distinguishes between compensation and dividends, between management and ownership decisions, and places value on the contributions of both active involvement and passive equity holdings. That way you can find the right balance between merit and inheritance.
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