How to keep the ‘family’ in the family business; Fewer than 15% of family owned companies will still be held by the same family beyond the third generation. Here are some tips that might help your family survive the transition

How to keep the ‘family’ in the family business

Drew Hasselback | February 18, 2014 7:00 AM ET
I have written about prepping for business succession in the past. Other FP Entrepreneur columnists have addressed the topic, too.

Those columns discussed succession in general. But what about succession in a family business? Less than 15% of family owned companies will still be held by the same family beyond the third generation, according to one study. The family dynamic amplifies some of the emotional issues that arise in succession talks, and it erodes some of the caution that might otherwise be present in situations where business owners aren’t related.

“Family businesses are subject to all the pressures of a regular business, but they have this added complexity because the owners and employees are related to each other,” says Michael Henry of Houser Henry & Syron a small law firm in Toronto that does a lot of work with family-owned businesses.

Toss family ties in the mix, and you can easily envision two extreme scenarios. Either the family doesn’t get along at all, and efforts to shift ownership from one generation to the next end in tears and litigation. Or the family gets along so well that no one thinks it necessary to sort everything out in writing — then suddenly it’s too late, and efforts to shift ownership from one generation to the next end in tears and litigation.

Mr. Henry has some simple yet crucial advice for families that own a business: Hold regular family meetings. A family meeting can promote co-operation and unity within the family, and reduce stress and disagreement at crucial times. “The critical factor in a successful family business is communication,” he says. “The absence of good, clear, ongoing communication is the surest sign that the business is in trouble.”

My column on succession planning recommended you have a shareholders’ agreement. These are relatively simple documents that cover a lot of ground. They outline the rights of each shareholder or class of shareholders, they explain how to divvy up corporate profits, and they formalize a process for decision-making. Perhaps most important for families, they can provide specific rules on when and how control of the corporation can change from one generation to another.

A common issue with family-owned companies is dispersion of shares. Parents might own 100% of the business, but if they divide that ownership equally among their three children, who then divide their holdings among their children, you can wind up with a large number of family members owning slivers of the pie. While the parents are still in the picture, they can provide uniform direction. As ownership divides among the subsequent generations, that authority is replaced by a chorus of voices.

Mr. Henry suggests parents transfer shares not directly to their children, but to a company set up to hold the shares for each of those second-generation family members. This can serve to reduce the number of voices clambering for a say in the direction of the business. “It’s much harder for siblings to tell each other what to do than for parents to tell their children what to do,” he says. “And what was easy between siblings is harder between cousins.”

In many small businesses, the shareholders are also the officers and directors. Where these people are family members, this can lead to problems because there is no independent source of arms-length advice. If it’s not possible or desirable to have a non-family member sit on the board of directors, a possible solution is to set up a board of advisors, Mr. Henry says.

Such a board can be particularly helpful in deciding what to do about management succession. It’s hard for parents to evaluate the suitability of their own children or close family members. “You also need some outside help there,” Mr. Henry says.

And about that management succession, he says, you want to have a plan in place long before the issue arises. This will avoid squabbles among future heirs. It can also be a positive thing, since the transparency of the process can make it easier to groom that next generation manager for the role.

Drew Hasselback is Legal Post Editor of the Financial Post. He is a lawyer called to the Bar of Ontario