Assuring Financial Freedom
The single most common comment we hear from next-generation family leaders while their parent retains managerial control is this: 'The boss won't listen to me; won't let me implement my ideas; won't invest in the things we need to be successful in the future.' These heirs apparent often perceive this behavior very personally, often as a lack of respect, confidence, trust or even love.
We got a clue as to what was really going on when we saw a father and son arguing about an investment advocated by the son and resisted by the father. 'Dad, you understood risk when you were my age! You made this kind of investment! The business wouldn't be what it is today without your willingness to make these kinds of decisions!'
'Right!' his father said. 'I took risks when I was your age. But I did it with my money. And now you want to do it with my money!'
Especially with business founders who both identify strongly with the businesses they created and have the majority of their wealth tied up in the business, generational progress can be stopped in its tracks by issues related to personal financial freedom and security. Worse, the friction engendered can be interpreted in ways that magnify the destructiveness of these conflicts. Moreover, lack of personal financial freedom often leads to personal decisions like refusing to transfer managerial control or stock ownership to the next generation even when it is clearly best to do so that compromise the business and the family. One of our favorite cartoons has a middle-aged man pointing to factories through the window and saying to his adult son 'Someday this will all be yours but right now I'm still waiting for my father to give it to me!'
We hear a similar message in different ways in other family business circumstances. 'Don't you dare risk my inheritance,' says an outside family stockholder to his cousin, a third-generation CEO. 'I sure wish we'd bought back my cousin's stock sooner so we wouldn't be forced to go public,' laments another. And still another successor ponders: 'If I felt more financially secure, I wouldn't worry about whether or not I'm selling my soul.' All these expressions make the same point: If key owners don't feel they have personal financial freedom, family friction and business compromise are inevitable.
We find that when a family member feels dependent on the family business for his or her financial security, resolving that perception becomes a critical priority. Similarly, the more free and independent owners feel, the more likely they will be committed to family business continuity. Shareholders with similar feelings are more likely to be supportive and content.
The first time financial freedom becomes a priority for a family business is when the founding generation approaches retirement age. It's hard enough for founders to 'let go' of the business they birthed, but it's even harder if they feel their exit makes them dependent on their kids for their security and standard of living. We find only rare instances in which parents will fully turn over control of the business to successor unless they feel personally financially secure.
To satisfy this need, most think first of life insurance. Unfortunately, the real concern is financial support during the rest of what will hopefully be a long life! Therefore, a key step in successful succession planning is to fund the parents financial security. There are several possible approaches:
Fund an annuity over a long period of time
Actually purchase some of the parents stock even if they are willing to leave it in their wills
Bonus the parents aggressively until their 'nest egg' is financed.
In each case, it's essential for the parents to specify the level of liquid assets and income that would allow them to comfortably and willingly depart from the business. While these approaches may seem troublesome, redundant, or expensive, they greatly lessen the normal pains of succession transition.
Just as it is unhealthy for the senior generation to 'live off' the business, successors who could not leave the business without destroying their lifestyles also create an unhealthy situation. Successors in this situation often feel they are 'selling their souls' and have little dignity. On the other hand, we find, that if successors have some personal financial independence, they are more forceful and effective leaders of the business.
While young successors can't maintain their sense of independence through wealth, they can achieve it by accumulating some savings, adopting a standard of living more modest than their income, and, most important, by honing their personal competence to the highest degree. We find that family members who are too dependent on the family's income to fund their lifestyles are not the best employees. Ironically, those who can say 'I can do just as well on my own' have the greatest sense of adding value and taking responsibility. They make the best family business leaders.
At least one-fourth of all family businesses reach the stage when many family members own stock even though they don't work for the company itself. Outside family stockholders often look to dividends or perks from the business to finance their personal needs. They often come to think that they have a right to help run the business as well.
Nothing is more embarrassing and disruptive to a family business than a family member who feels no power in day-to-day business operations and who feels 'stuck' in their stock ownership position. Before this situation develops, we urge family businesses to develop a plan and a formula for stock redemption. When the formula is established early in the business life, it can be biased to preserving the business. Since most stock passed on is a 'gift' from previous generations, it is a good idea to establish a stock redemption formula while the stock is still viewed as a 'gift,' the price of which should not be argued over.
One approach we like is to set aside an annual pool of funds as a percentage of profits to use to re-purchase any shares of stock offered. We find that family shareholders are more likely to remain as satisfied owners if they believe they have an 'out' or at least a 'partial out'.
When family business founders, successors or inactive owners feel dependent or trapped, the greatest potential for difficulties occurs. Financial freedom is really just a perception, but the sooner it's addressed, the less expensive it is to respond to. And the good news is that the more financially secure and free family members feel, the more committed the family and the more successful the business are likely to be.
Establishing a Stock Buyback Plan
A company has seven family member shareholders and $270,000 in after-tax profits. The owners and the board set up a policy that allows family members to redeem in any year their shares to no more than one-third of profits ($90,000).
In this family firm, shareholders were looking forward to selling some stock. Three wanted to redeem $20,000 each. One wanted to redeem shares worth $40,000. Because redemptions are on a pro-rata basis, in this case, the company purchased all $20,000 wanted by each of the three and $30,000 (of the $40,000 offered) from the fourth family member.
In some businesses, funds not used this year can be carried over until next year. In other family businesses, whatever is not petitioned isn t held over until future years. This policy decision often rests on the family's instinct for people s eagerness to sell.