“[He is] the epitome of the child with rich parents who wakes up on third base and thinks he hit a triple.”A recent article in the New York Times about the bickering Neumann family caught our eye with that description of an entitled family member. The taunt is cutting enough without context, but the depth of the family’s issues comes into clearer focus when we learn that the quote is from a woman describing her own father. Though not a family business fight, the Neumann family strife does revolve, predictably enough, around money: specifically, the disputed sale of enormously valuable artwork owned by the family. Perhaps most disconcerting is not the specifics of the Neumann family travails, but the broader overall trends in intra-family legal disputes noted in the piece. According to one partner at the Los Angeles law firm, Weinstock Manion quoted in the article, “We can’t hire enough attorneys.” That comment alone is a sad commentary on the inability of a successful family business to guarantee family harmony. So how should family business directors think about their role in making sure their family does not turn into the Neumann’s? In our experience, it is important for directors to think about this question in terms of both preventing family strife from starting and de-escalating volatile situations that already exist.
The Ounce of Prevention
Among the responsibilities of family business directors is providing guidance and oversight to the risk management function of the firm. Family businesses face manifold risks associated with the operating environment, industry and economic conditions, capital availability and the like. But directors cannot afford to overlook the risk of shareholder dissension to the business. Certainly, there are no guaranteed strategies for preventing shareholder discontent, but in our experience, most cases of serious shareholder angst are rooted in communication failures and breaches of basic economic fairness.
Prioritize Communication
Family business directors seeking to minimize the risk of shareholder in-fighting need to prioritize effective shareholder communication. Shareholders crave and deserve regular, objective information regarding the performance and outlook for the family business. One of our colleagues relates the advice of his mentor in the asset management business: “Clients don’t leave because they lost money, they leave because you didn’t communicate with them while they were losing money.”
Effective shareholder communication requires more than sending detailed financial statements to shareholders at random intervals. Family business directors who prioritize communication establish a schedule of timely communication throughout the year that focuses on turning financial statement data into a clear narrative regarding the company’s strategy, recent financial performance, and outlook for the future.
Commit to Basic Fairness
Retaining earnings only to acquire low-yielding assets that do not fit any discernable corporate strategy will likely raise hackles.
Second is a commitment to basic fairness. This means making corporate finance and operating decisions that benefit all shareholders, not just one generation or select employee shareholders. Basic economic fairness manifests itself in multiple ways – here are a few examples:
- The family business has a coherent strategy that guides investment and distribution decisions. If the shareholders understand and approve of the strategy, reinvestment of earnings to fund attractive capital projects in lieu of distributions will generally not frustrate shareholders. On the other hand, retaining earnings only to acquire low-yielding assets that do not fit any discernable corporate strategy will likely raise hackles.
- The family business has a clearly defined capital structure target. If shareholders know what the target capital structure is, the rationale for it, and have been asked for input regarding risk tolerance, the likelihood of debt-triggered shareholder anxiety is reduced. If instead, the family business borrows money (or refuses to borrow prudent amounts of money) at random without any long-term goal or objective, shareholder distrust is likely to rise.
- Family shareholders who also work in the business are paid fairly. Managing a family business is hard. Non-employee shareholders are occasionally guilty of thinking that managing the business should be a form of volunteer work, while family business insiders sometimes think that non-employee family members aren’t entitled to any economic fruits of their labors. Both of these perspectives are misguided, and left unchecked, can mushroom into serious strife. Since the potential for mistrust can run so high when it comes to compensation, this is a great reason to have a few truly independent directors on the board to help provide insight regarding what a real market-equivalent wage is for positions held by family members. In the end, appropriate transparency is crucial.
The Pound of Cure
Prevention is never totally effective. Sometimes the acrimony has reached a point that family business directors need to find a way to de-escalate the situation for the good of the business. Below, we suggest a few paths forward.
Objectively Evaluate Shareholder Complaints
The first step is for family business directors to objectively assess the economic merit of the various complaints of the disgruntled family members. If the complaints have merit, then appropriate changes should be made. Framing the dispute in terms of business decisions that have rational economic answers can help de-personalize the situation and make a workable resolution much more likely.
Identify Shareholder Clienteles
Framing disputes in terms of business decisions that have rational answers can help de-personalize the situation and make a resolution much more likely.
As family business directors, how well do you really know your family shareholders? Outspoken Uncle Jerry may be the one calling for changes, but timid Aunt Tess may feel exactly the same way. Directors can benefit from having a mechanism to gauge shareholder attributes and preferences. If done well, this process can reveal groups of shareholders that have similar attributes and preferences. If a given clientele is large enough, it may be appropriate to consider structural changes that specifically address the clientele’s needs. This may involve a distinct class of shares or spinning off a particular operating division.
Willingness (and Will) to Separate
Finally, the disagreement may be so fundamental that the best path forward for all parties is to redeem the shares of the disaffected shareholders. For shareholders being redeemed, this requires a willingness to forego potential future distributions and capital appreciation from the family business. For the remaining shareholders, this means taking on additional financial risk to pay for the redemption. For both parties, a redemption transaction requires agreement as to the price paid and terms of payment. Converting arguments to economic transactions forces both parties to carefully assess how strongly they really feel about the sources of disagreement and may help them disentangle the personal and business components of the dispute.
Conclusion
The biggest threat to the sustainability of your family business may not come from competition or evolving technologies. It may come from the family itself. As a family business director, you should be attuned to this risk and take the steps necessary to help prevent, or at least de-escalate such situations. For an outside perspective on the economic merits of a family dispute that threatens your business, call one of our family business advisory professionals today.
