Tough Economic Times Put Family Businesses to the Test
By Amy M. Schuman
In last month’s Family Business Advisor®, we explored the impact of tough economic times on family businesses. This month, we provide some suggestions on how family businesses can prepare for and deal with an economic slowdown.
Recently, a good friend confided in me that she’s been waking up in the middle of the night worried about the economy and its effect on her family and business. She’s not alone. Business-owning families across the country are concerned about the impact of oil prices and the impending economic slowdown. For many, the demands and tensions of tough economic times highlight even more clearly the need for trust and open communication between family members. These demands and tensions also emphasize the need for economic discipline, clear policies, and well-established systems of family and business governance.
Over the last 15 years of economic prosperity, the financial success of many family businesses has spawned a number of bad habits. A recent meeting I had with a client led to a discussion of the economic outlook in his industry—rising fuel costs together with a more competitive landscape have led to a shrinking bottom line. The natural tendency in tough economic times is to cut costs and consider letting some employees go. Upon further discussion with my client, it became clear that the family members around the table in management positions were reacting to the pressures without a clear understanding of the true cause of their financial troubles or the likely financial impact of their decisions.
I asked the founder of the business how he ran the business seven years ago, when it was growing rapidly. As expected, I heard that there were regular weekly meetings that included a review of the financials and in-depth analysis of revenue and cost trends, and a comparison to a budget. My client admitted that as the business grew and profitability exploded, the budget process became less disciplined. Weekly meetings became monthly meetings and then disappeared altogether. Further discussion also revealed that family tensions were ignored as the business grew and bank accounts expanded.
Suppression of family conflict did not resolve it, but only made it more deep seated. This lack of financial discipline combined with increasing tension in the family and a shrinking bottom line were leading to a real challenge. Beyond economic discipline, families must have the discipline to stick to their policies and succession plans. Families can avoid creating additional tension at an already challenging time by enforcing discipline in all areas of family business planning.
Family Business System
As frequent readers of Family Business Advisor® know, managing the intersection of the three systems present in family business—family, business, and ownership—is a key to family business success. Tough economic times create stress across the system. Business performance may suffer and tough decisions need to be made. Family conflicts, which are easy to ignore when the return from the business is good, rise to the surface during an economic downturn. Family members not in the business may blame those who are for not addressing financial problems sooner. Owners have to deal with the possibility of cutting back on distributions or possibly even selling the business. The conflicting goals, which are often present in the three systems, are best managed by policies and processes that ensure all concerns are addressed and brought into alignment.
The tendency is to ignore policies and processes when times get tough. However, a sound family business infrastructure is even more crucial in tough economic times. Families have a dividend policy stating that dividends will only be paid when they do not threaten the viability of the business. In tough economic times, dividends may need to be suspended. During an economic downturn, the test will be whether or not family members follow the policy.
Enforcement of a family employment policy is another example. Breaking the policies that you have in place is not good for the business or the family.
There does need to be some flexibility in policies and processes to address unforeseen challenges. However, families must consider the long-term implications of breaking rules they originally made in the best interest of the business and family. To weather an economic downturn, families must build a strong infrastructure and stick to it.
Tips for addressing a downturn
Build or return to sound business management practices. Tracking and enforcing responsibility for financial results is important in good economic times, but it is essential in a downturn. Creating a realistic budget to ensure that revenues will cover costs is also imperative. This exercise should consider what areas can be cut back if revenues shrink substantially. Once the budget is complete, create a process for tracking performance against the budget so that any changes in the environment faced by the business are identified quickly. Developing solutions in areas that are not tracking against the budget and then holding management accountable for delivering results (or alternative solutions if budget expectations are no longer realistic) are a natural outgrowth of the process. Last but not least, it is critical in uncertain times to hold regular management meetings where the team can discuss changes in the business environment and also develop plans to address them.
Be prepared for lower distributions. A business that has prospered over the years and has always paid generous distributions or dividends to its shareholders may find it difficult to meet these payouts during today’s challenging economic times. A family shareholder group that has taken the time and effort to learn about their business and the factors that make their dividends possible will be in a much better position to anticipate and adapt to changes in their dividends than a shareholder group that has just accepted their dividend checks without any effort to understand what lies behind them.
Stick to your employment policy. Many families require members of the next generation to work outside of the business for several years before the next generation can work in the family business. However, when the economy slows and a well-paying, desirable job is tough to find, the family may be tempted to ignore its employment policy and hire young family members right out of college. The family may ask, “What good is having a business if we can’t help the kids during tough times?” A valid question—but perhaps the members of the family would be wise to remember why they created the policy requirement in the first place. Most family members are able to make more significant and enduring contributions to their business after having a chance to learn in other work settings. Just because it’s very difficult to find work, is that requirement no longer relevant? Rather than simply ignoring the established policy, a family must seek ways to help young, inexperienced family members without abandoning its stated policy. There are many ways to accomplish this, and each family will find its own way. For example, the family business can help family members with résumé development, interview preparation, or even introductions to possible employers.
Honor the succession plan. A father or grandfather who has turned management of the business over to members of the next generation is often tempted to jump back into action during tough times. The family may welcome and encourage their involvement because of Dad’s or Grandpa’s history of success under pressure. Will the family allow the current leadership to lead or will there be too much fear for the family to place its trust in the next generation’s leaders?
An “either/or” solution is not the answer. Finding a way to access the wisdom of the senior generation without cutting off the junior generation at its knees will be imperative. Combining the wisdom of the past with the talents of the present will be the key to success in these tough times.
A family’s response to these economic times could be seen as a test of will and commitment. A family shareholder group that has worked hard to establish policies and governance systems will certainly be led to question the wisdom of those policies, which were likely created during times of peace, calm, and even prosperity. Will the family stick with its policies, even if individual or collective suffering results in the short term? What will take precedence—the needs of the business, or the needs of the brother who requires his dividends for a mortgage payment or the sister whose daughter needs a job?
All systems will begin to fray or fracture at their weakest point, when the going gets rough and pressure starts to build. A family system is no different. Many family businesses are seeing and feeling more than a few cracks starting to emerge in response to today’s increased economic pressure. By returning to the tried and true—strong governance, agreed-upon policies, family education—families can use the challenges of these tough times to become even stronger and more unified.