Equal is not always fair in family businesses

As we enter a post-pandemic environment, many baby-boomer owners are re-assessing their continued day-to-day involvement with their business. Many current generation owners are accelerating plans to transition ownership to the next generation or sell to outside buyers. Family-owned businesses are hot commodities fueled by over 1.5 trillion dollars of “dry powder” from private equity firms. Consequently, the current generation is being forced to address the age-old issue of “fair versus equal”. Specifically, should children not involved with the business be treated equally to those children involved with the business when it comes to ownership transfer or sale? The question becomes “is equal fair?” when it comes to the next generation.

After advising family-owned business for many years, it has been our observation that over half of family business owners intend to divide ownership equally amongst their children. Whether or not they work in the business does not seem to matter to these parents. However, we must ask the question, is that the best approach to family wealth transfer? Our experience would suggest not.

Confusing fairness with equality has the potential to cause conflict, create resentment and impact the family dynamic into the next generations. Although every family and family business is different, there are a few common sense rules implemented by the most successful and conflict “minimized” families. A few of those rules are:

1. Assess the fair versus equal argument through the lenses of the family business leader and the patriarch/matriarch.
2. Use a merit-based approach to awarding ownership to the next generation. The children that have added value to the business, helped grow the value, invested sweat equity and have declined other potentially more lucrative opportunities outside of the business should be rewarded with ownership interests.
3. Treat the children active in the business as you would treat a key employee – reward them for performance and loyalty.
4. Consider the equality issue relevant when you are addressing estate issues and considering the disposition of non-business assets. In that case, don’t penalize the children that have worked in the business and count their ownership against the non-business assets.

Owners should also consider the perspective of the children that are not active in the business. They may not want to receive assets that are not liquid and carry more risk than other family assets. Without controlling interest, they are simply coming along for the ride and oftentimes have no say in the operations and strategy of the business. In addition, their ownership shares may be illiquid without the proper buy-sell mechanisms in place. As the generations pass on, this often leads to distrust and resentment between the family members that own and operate the business.

On the flip side, we have observed growing resentment on the part of the children active in the business toward those that have ownership but are not active. In a successful family business that is growing and increasing in value, the children on the inside have contributed to that increase in value but their siblings are benefiting without contributing.

So what should family businesses do to avoid and/or address these issues? Our research has indicated that over 50% of family businesses have no transition plan or strategy in place. In order to successfully transition ownership and control to the next generation, we recommend creating a family enterprise strategy. It starts with involving the current and next generations in defining a shared vision for the future of the family business. Issues to discuss include:

1. When does the current generation plan to step aside?
2. Is there a shared desire to keep the business in the family?
3. Should we sell to an outside buyer since multiples are high and private equity firms have a lot of “dry powder”?
4. What is the growth strategy for the business?
5. Do we need investment capital? If so, where will it come from?
6. If we intend to hold, who will lead the company in the future?
7. Are there any qualified family members?
8. Shall we invest in the development of the next generation?
9. What happens if something unexpected happens to the current owner/leader? Do we have a business continuity plan?
10. Are there buy/sell agreements in place?
11. Do we have adequate insurance in place?
12. Do we have the proper governance policies in place for future generations that may address hiring, firing, compensation, performance evaluation, non-family ownership, etc.?
13. Does the estate plan reflect the latest desire of the current generation?
14. Should the current generation be gifting ownership interest to the next generation(s)?
15. Have we been transparent on the company valuation, family’s salaries and the future needs of the company?
16. If trusts are set-up for future generations, who should the trustee’s be?
17. Is there an advisory board or formal board of directors in place?

These are a few of the many questions that should be answered through the development of a family enterprise strategy. Through this process the family should come to some consensus regarding the most important issues facing the family and family business. Along the way, the “fair versus equal” issue will be addressed in a thoughtful, constructive and transparent way.