The Family Business Thrives: Will the Next Generation?

By Glen R. McCluskey, Attorney At Law

Family businesses make up more than 90% of the world’s companies. The family business is stronger than ever in American and around the world, according to the Economist Magazine, To Have and To Hold, Special Report: Family Companies, April 18, 2015, Vol. 415, Number 8934.

Family businesses are those that are started by individuals or groups of people in the same family.  Family member’s likely work there, and the companies are passed on in one form or another to the heirs of the founder(s)

Most are small, but some are huge, like Cargill. Some are closely held by a small group of family managers, others are owned by the family, but run by outside professional managers.  Family businesses are an important part of the economy in Minnesota, the US, and the World.

History of Family Businesses

Long ago in the early history of the world, farming was king.  Farms were hacked out of the wilderness and operated exclusively by the family.  The larger the family, the more workers and hopefully the more productions and profits for all.   As people moved to the city, they looked for work with existing businesses.  Or they often opened up their own businesses to ply their trade as shop owners, blacksmiths, and an unending stream of merchant and service-based operations.  These businesses were small, but they stilled required capital investment to start and operate and labor to run the business.  Unless, the business lent itself to being a one-person shop (which limits profitability) other people needed to be involved.

Capital investment might come from other family members who had already established themselves and were willing to invest in their cousin or nephew’s business ideas.

It was believed, according to the Economist, that family businesses would largely disappear as the economic world evolved. They would be replaced by public companies that obtained investment, by selling stocks (part ownership) of the business.  Some business also need labor with skills that cannot be readily obtained from family members.

This has been partly true, but today some of the world’s largest companies are still under family influence. These include Ford Motor Company, which although its stock is sold on the NY Stock Exchange, it is still managed by a family trust.

Strengths the Family Business

Family businesses can be effectively and profitably run. This is often because the values shared by the founder are passed on to the next generation who can be trained to run the business according to the same successful principles of the founder.

The workforce can also be extremely loyal.  Loving sons or daughters who are valued and well-paid, will not readily seek employment somewhere else.  This is especially true if they have an equity stake in the business, or will have upon retirement or death of the founder.

Many family business owners started from nothing and as such a very frugal. They do not spend money unwisely always keeping an eye on the economic position of the business and the future.  They are not in it to make a “quick killing and get out,” This is a strength in the present, but is a value that can be passed on to future generations.

Traditionally, family businesses also have not been reluctant to promote women to leadership roles.  This is good for women, but also for the business itself when the woman promoted is skilled and experienced and understands the business and its formula for success.

Management control and equity control are also seen as strengths of the family business.  Keeping ownership in the family means no outside shareholder pressures to make short-term profits, when the long term will bring wealth not only now, but for the next generation.

Operating the family business     

A family business has unique characteristics, but it must also adhere to general business principles.  Those are many, but include using the rights laws and business techniques to set up the business to reduce tax liability and protect personal assets by creating the right form of business entity, such as an LLC, or family limited partnership.

If there is more than one owner, or there is likely to be in the future, the family business should have a written sent of operating rules. Such an Operating, Shareholder, or Buy-Sell type agreement will reduce arguments about managing on a day to day basis and provide rules for everyone for now and into the future.

Succession planning

A well written operating agreement is essential, but so is a shareholder or Buy-Sell Agreement.  It charts a clear path to future ownership. A properly drafted agreement will state exactly who owns what percentage of the business and when they wish to sell their shares, to whom they can sell them and for how much.  Without these rules in place, family members will be left to argue about the desires of the founder, if they have died or become mentally incompetent.  As well, lack of a written plan may allow certain family owners to “cash out” by selling their shares to outsiders for whatever price they can get.  This may put an end to family ownership and control bringing short-term profits to a few and derailing the long-range vision of the founders.

The current owners must also give thought to how ownership and management may be diluted over time.  In theory, a business run by John in generation one, will pass down to John Jr. and his brother Joe. Then to the offspring of both and so one.  Unchecked, the business may have a dozen owners/managers all of whom cannot be depended upon to have the exact same set of values are John Sr.  It is better to have an agreement in place to state who will own the business, but also how managers are selected.  This way management can be given to those best skilled to run the business and keep profits flowing.  Distributions on the ownership stake is treated separately with owners perhaps getting yearly dividends, and managers getting dividends and salaries.  However, there are many permutations based on the needs and desires of the family and economic cycles.

This succession planning is as important as operating the business on a day to day basis and should be part of every family business’s plans.

Conclusion

The owner(s) a family business must keep their eye on the present and the future.  Operating and Shareholder agreements crafted to the unique desires and needs of the business as essential to preserve ownership and control for future generations and to assure wealth is not squandered in the short term. Estate planning documents such as wills, powers of attorney, trusts and the like also come into play.

I look forward to discussing you family business needs both present and future with you or with all the stakeholders.  Working together we can assure you reach your business and succession goals and keep the family business vibrant and within the happy family.

Glen R. McCluskey

Attorney At Law

St. Paul, MN 55104

651-646-2669

Glenlaw@glen-law-office.com

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