Bulletins | June 8, 2017

Professionalising The Family Business

This article examines some of the dynamics of family businesses, with lessons for wealth managers catering to these organisations and their owners.The following article on matters around family-owned businesses is by Rosalyn Breedy, corporate and financial services partner at Wedlake Bell.

UK family businesses have been shown to be less productive than their peer group of non-family businesses in UK in a recent survey by the Office of National Statistics.

(i)Key points made by the ONS survey are that lack of professional management and an inability to recruit top talent are problems which disproportionately affect family businesses.

Similar findings were reported in 2016 by PricewaterhouseCoopers, which concluded “that family firms have toprofessionalise the way they operate by instituting morerigorous processes, establishing clear governance, andrecruiting skills from outside”.

(ii) Of the family business owners surveyed by PwC, 43 per cent agreed and saw these as key challenge for the next five years.

The ONS plans to do further research in this area. However, an extremely insightful US research paper entitled “The impact of incentive compensation on labor productivity in family and non-family firms”, (iii) which was referenced in the ONS survey, may hold the key.

The paper postulates that family businesses may experience lower labour productivity because of ‘adverse selection problems from labour market sorting and attenuation’.

In essence, high productivity is a result of having hired and retained high performing talent. However, high performing talent is put off working for a family firm because they perceive that owners will pursue non-economic goals and favour family employees over non-family members. External candidates are also concned that they might not be adequately rewarded for their contribution to the business. Interestingly though, igh performers and low performers are equally motivated by the positive values of a family business.

Since high potential and high performing employees are likely (all things being equal) to have the most employment options, they are more likely to want to work for non-family firms where they perceive their career prospects and earning potential to be greater.

As high-performing employees continue to act in this way, family businesses find themselves recruiting from a smaller pool of candidates. Over time the pool also becomes less experienced and qualified than the candidates who are able to pursue options where the interests of the owners and employees are better aligned. Clearly, this is a generalisation and there are many exceptions to the rule, but the principle merits further investigation.

The other challenge which family firms need to address is to plan for succession. The PwC survey showed that only 15 per cent of family businesses surveyed had a robust documented succession plan, concluding: “In the next five years it is likely we will see the biggest inter-generational transfer of wealth the modern economy has ever seen. Much of this wealth will take the form of shares in family businesses, which is why a more robust approach to succession planning is such a key priority for the whole family business sector – and indeed for the economies they help sustain.”

Family businesses who want to be successful need to ensure that the following items are squarely on their board agenda:

Remuneration strategy – This includes benchmarking against the market rate, and consideration of equity sharing through performance-based employee incentive plans and service agreements;

Family dynamics – Problems need to be addressed, possibly with the help of a neutral trusted adviser who can help the family to deal with fears of giving up control and sharing rewards, dysfunctional behaviour and poor communication. The family adviser has a toolbox of legal instruments which can help a family to protect its wealth, including wills, trusts, letters of wishes, philanthropic foundations, powers of attorney, family constitutions, pre-nuptial or post-nuptial agreements.

Focus on succession – Failure to organise the affairs of a family business puts off top talent from applying and can also result in high turnover if employees feel that the business is suffering.

Use of objective criteria to decide on and reward the next generation of leaders – It is possible to retain family ownership and control provided the business is successful and other investors and top talent are fairly rewarded. The family need to decide whether the business is to be grown or sold.

Tools to achieve an effective succession plan – Shareholder agreements, family funds (OEICS and investment companies), appointment of independent directors and institution of a proper board governance separated from the family.

However, tools only work when the family fully understands the nature of the challenge faced and has developed a strategy in conjunction with their professional advisors.

Please click here to read the article first published in Wealth Briefing on 8 June 2017 (the link requires registration).