A fifth-generation family business in Kentucky was facing a crisis. One of its four sibling owners had suddenly announced a pending divorce. The unexpected event posed a serious threat in the minds of the other brothers: Would a disgruntled ex-spouse be awarded her husband’s ownership shares in the privately held corporation, ushering in an unwelcome business partner to gum up the works?
At first, a solution to the problem seemed straight-forward: The company stockholder agreement required the company to buy back shares from a partner in any divorce proceedings. Alas, formal agreements are one thing and human emotions another. The divorcing brother sensed resentment on the part of his siblings: shelling out company funds to purchase his shares might well threaten the company’s growth by hampering its investments in new projects. It was apparent that failing to resolve this issue would poison the relationship among the brothers, with serious ramifications to the bottom line.
What was the solution? Later in this article we’ll answer that question. For the moment, though, our story illustrates a larger problem: Personal conflicts are common and costly occurrences in family businesses.
“Any family business that gets past the first generation starts experiencing an exponential increase in the number of people affected by company operations,” said Sam Brownell, founder of Stratus Business Advisors. “The organization eventually ends up dealing with a huge family with multiple branches, along with all kinds of potential claims to profits and decision making.”
Talk It Out
Many family business conflicts can be avoided—or overcome—through the efforts of a “family council”—a small group of related individuals who serve as a collective sounding board when personal issues threaten company operations. They differ from management teams and boards of directors, both of which deal with business matters and are ill suited to handle the kind of family tensions that so often escalate into costly disruptions.
“Family councils can be good venues for airing grievances in a structured way,” said Travis W. Harms, the leader of Mercer Capital’s Family Business Advisory Services Group. “By avoiding toxic back-channel conversations between family members, they can help sidestep issues that can threaten business profits.”
One common source of conflict is the company employment policy, which commonly deals with some pretty sensitive issues. Here are some examples: Who among the relatives are entitled to company jobs? What are the criteria for full-time or part-time positions? Does the company create jobs for family members or just wait for positions to become available? Must successful job applicants possess certain characteristics, experiences or education?
It’s not uncommon for managers to have one set of answers to the above questions, while the parents of a child—maybe residing several states away—will have another. “A family council can be instrumental in resolving potential conflicts as the second and third generation reach employment age,” said Barbara Dartt, a principal consultant at the Family Business Consulting Group.
Councils can also set up systems that help ensure future management continuity. “Embroiled as they are in business operations, the company’s current management will not be thinking about grooming future generations for board or management positions,” said Christopher J. Eckrich, a senior advisor at The Family Business Consulting Group. “But this topic can be a critical concern for a family council, which might well decide to set up educational systems to prepare future leaders.”
Management Conflict
Sometimes the border between family and business is a bit fuzzy. The result can be a mismatch of goals. Take the area of risk tolerance. “Managers with incentives to grow the business rapidly may feel the best way to do so is to engage in acquisitions,” said Eckrich. “However, buying other businesses often requires borrowing money, and that can be resisted by family members who want to diminish risk by maintaining a low debt-to-equity ratio.” In such cases, said Eckrich, it’s not unusual for a family council to accommodate business goals with a compromise. “Rather than green light a huge acquisition, they may opt to take on a series of smaller ones.”
Company initiatives that make sense strategically can also butt up against family values. Eckrich gives a commonly encountered example. “Maybe a board decides to close the company headquarters located in a small town where a business grew up and move operations to a larger city. But the act of closing the headquarters grandma and grandpa created 60 years ago can end up exploding the family.”
Wise boards run such sensitive initiatives by the family council for discussion and feedback, said Eckrich. A proactive approach can reduce the chances for conflict.
Resolving such issues can have a beneficial effect on company profits. “In economic terms, the family council can strengthen the emotional connection between the family members and the business operation,” said Dartt. “The result is that the organization benefits from patient capital owners who are willing to leave their money in the business for long-term return.” This kind of financial loyalty can be especially important for those enterprises with family members residing in distant locations. “A council can ensure that widely separated family members understand they have a voice in decision-making and feel a sense of pride in the enterprise.”
A council can also serve as a useful venue for family members to reach accommodations on conflicting personal goals. “We often see situations in which some family members feel emotionally connected to the business and want it to see it continue, while others are more interested in having their money go elsewhere,” said Dartt. “Maybe they want to make an addition on their house, or put their kids through college with no debt, or buy a vacation home. These wildly different priorities can tear a family apart.”
In such cases, family councils can obviate costly flare-ups by providing for the cash-out of some ownership shares while ensuring that the cash outlay does not harm the company’s future growth.
Keep It Real
Launching a successful family council requires some thoughtful planning, including who will be on the council and how it will function. “Someone has to decide what categories of people will serve on the council,” said Harms. Very often, membership will be open to any family member, regardless of share ownership. Other councils might be restricted to categories such as first-generation owners, siblings or spouses. “The emphasis should be on the first word: It’s a family council, not a business council or a board of directors.”
Then, of course, there is the decision about which specific individuals will join the council. “In the very beginning, and often for a long time after, the composition of the family council will be segregated by family branches,” said Harms. “Each of four branches, for example, might designate two individuals.”
Yet, as family trees get more complex, branch dynamics can fracture. “It’s not healthy if branches turn into factions,” said Harms. In such cases, the company might start assigning representatives from a larger pool of prospective family groups, including those from multiple generations and stepchildren.
How big should the council be? Large enough to be inclusive, but small enough to allow for timely decisions. The majority of councils range in size from six to 12. “In some families where everybody may want to be on the council, keeping it to a manageable size is a challenge,” said Harms. Other times, the converse is true. “Council membership can be an extremely thankless job, and if people who pour a lot of time into it feel their work is not appreciated, you can quickly run out of volunteers.”
Take Action
Now let’s return to the story that opened this article. A fifth-generation family business was facing the possibility that a required buy-back of a brother’s ownership shares might hamper future growth. What was the solution? The company called a meeting of its family council, whose members decided to arrange for a new five-year note to fund the buyout, relieving the need to raid the company treasury.
“We were able to resolve the issue in a very collaborative way as opposed to people hiding their feelings,” said Brownell. “This was a nice conclusion because everyone felt their opinions were valued, and that their colleagues were in the business for more than just themselves.”
As this story suggests, family councils can help ensure the long-term success of an enterprise. If the benefits are obvious, the urgency is often unappreciated. “The most common mistake is inertia,” said Brownell. “Change is hard, and it can be difficult to have the kind of conversations that lead to the formation of a council.”
Too, the very dynamics of a family council can seem counter-intuitive to managers who grew up in the top-down, hierarchical nature of traditional business operations. “The most common challenge is marshaling the patience for a messy, non-linear management approach,” said Dartt.
For the same reason, there can also be a temptation to under-utilize the council once it is formed. Too often, companies go back to business as usual, canceling scheduled meetings, and letting things fester. That very reversion to seat-of-the-pants decision-making, of course, invites the very misunderstandings and resentments that a council was founded to obviate.
The good news is that an effective council need not disrupt daily operations. “Even if a council meets just once or twice a year for three or four hours, there’s a lot of communication that can be done in that time frame to avoid conflict down the road,” said Eckrich. “The family council can be a critical tool for spotting problems before they develop. I know managing a successful one is a challenge, but the payoff is pretty good for the folks who do it.”
Have You an Effective Family Council?
Will your family council adequately deal with interpersonal tensions? Find out by taking this quiz. Give yourself 10 points for each “yes” answer to these questions. Then total your points.
____ 1. Has the family council a defined mission?
____ 2. Does the council meet on a consistent schedule?
____ 3. Is there specific membership criteria?
____ 4. Is the council kept to a manageable size?
____ 5. Does an educational program train future managers and board members?
____ 6. Has succession planning been addressed?
____ 7. Does your council maintain contact with the board of directors?
____ 8. Is business strategy left to management?
____ 9. Does the council reach out to distant family members?
____ 10. Do you regularly assess the council’s effectiveness?
What’s your score?
Over 80: Congratulations! Your company has gone a long way toward creating an effective family council. Between 60 and 80: The council needs a bit of polishing. Below 60: Take steps now to get your family council up to speed.
