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Protecting the family business: When money becomes thicker than blood

Maria Daniel
Maria Daniel

Entrepreneurship: The spirit, the enzyme, the growth enabler of our economies. The entrepreneur has to be thanked for job creation, innovation and social and economic evolutions. Every business’ creation started with one man or woman. Sometimes a couple or three people get together to start something new. Then one day the idea comes to fruition; the man behind the desk now shares a table for two; the table for two turns into a dinner table. The dinner table then becomes the board room where important decisions are made for what will soon become a family business.

Family businesses are an important part of the world’s economies and certainly an important part of the back bone of the Caribbean economy. A 2012 EY survey conducted in collaboration with Family Business International found that only 30% of family businesses make it to the next generation. In 2013, EY’s survey of global college students with a family business background revealed that less than 30% had any intention of returning to the family business. In Europe, 30,000 jobs are lost because the transition from owner-manager to the next generation did not succeed. Migrating from entrepreneurship is not always an easy task. As the father looks across the dinner table, he has hard decisions to make. Are they capable? Do they have what it takes? Who has the burning desire to create a legacy from my hard work? There is also the invariable owner who thinks death will never be on his doorstep and fails to consider any of the issues of what happens next. He fails to let go and recognize that his business is solely dependent on him to survive.

Before the 2009 financial crisis, when economic times and company performances were still in “the bubble”, many studies and articles concentrated on high performing public companies and trying to convince family businesses to operate more like public companies. After the financial crisis, however, the story took another turn. The public companies were unable to withstand the financial crisis and large players crashed. Most family businesses, however, held strong and were resilient to the down turn. A study done in Europe showed that over 60% of family businesses grew by over 5% and one in six over 15% in the 2009 to 2012 period whilst public companies struggled to report any growth.

Resilience. How does one create a resilient business? Is it just a strong balance sheet? Is it the ability to make quick decisions over the dinner table? Is it ensuring that the genes and DNA from the founder continues through the blood line? Over the next three weeks we will be examining some of these issues that face both entrepreneurial companies and family businesses.
Firstly, for ease of reference, let’s differentiate. An entrepreneurial company is one which is owned and managed by its founder. The family business is a company that has now progressed ownership to the second generation and onwards of the founder.

In this first article, we will discuss the transition from entrepreneurship to family business, which has proven to be chaotic for some families and is one of the main reasons why looking beyond oneself is not always top of mind for the entrepreneur. The focus, however, is not only on the obvious succession issues faced but the options that can be considered by the owner. We choose to address this issue because we have seen the disputes, the loss of true family relationships and the ugly reality of when money becomes thicker than blood. These family fragmentations negatively impact the entrepreneurial ecosystem that is vital to economic stability and development. The entrepreneur (and for this part of the segment, we will include second generation sister-brother ownerships transitioning to cousins) is faced with the growing family business. The “who comes next” might join the family business for varying reasons includingobligation, inheritance, employment or the desire to create their own legacy. The reality is that the motivations of the owner and the next generation are usually not the same. To add to the complexity, there are in-laws to consider with the mingling of company and marital assets. Add a divorce to this and the inclement weather becomes a storm.

Family diagnostic

In deciding the next step for his business the founder/father needs to critically analyze his situation, what he wants and where it can go realistically. This is a tough exercise in introspection, retrospection and “facing reality” of the gene pool. The questions he should ask are:
• Am I building a legacy for future generations?
• Am I building a family life style?
• Am I looking for wealth creation for myself?
• Do my family members have the right attitude?
• Is there enough interest and capability to continue what I/we have built?
• Can the business sustain everybody?

More often than not that, no thought has been given to these questions or the owner dies and leaves the chaos for someone else to deal with. In these situations a number of scenarios can play out. We do not have the word allowance to go into all but we will summarize two scenarios to illustrate the importance of formalized structures:

Scenario 1
• Equal inheritance across all siblings and wife but only one or two take the baton and either join or now lead the family business. In this scenario, let’s assume the inherited asset grows significantly under the stewardship of new owners. The dispute: The “employee” shareholders begin to feel that everyone is benefitting from their hard work. On the other side of the equation, suspicion grows amongst the non-employee shareholders: Where is the money going? Where are my dividends? Where are the financial reports?

Scenario 2
• Equal inheritance. Most of the family members want to join the business but disagreement begins with the strategic direction of the business and who will lead it. Result: Internal disputes destroy value because stalemates on the operational and strategic direction of the business stagnates the business; value is lost.

This is all related to early thought about:Who is able; who should lead; am I creating a legacy? Is there a solution to deal with some of these issues? The answer: The creation of a Family Office.

Family Office

A Family Office is an organized structure that governs and manages the family wealth. This means the family businesses, the surplus assets and the marital assets are all dealt with in an organized structure. It does not take away the decision making powers from family members nor does it get involved in the entrepreneurial operations of the businesses. It provides the key elements:
• Governance and management structure; financial reporting , benchmarking shareholder reports
• Alignment of interest – one pool of advisors dealing with all assets
• Potential higher returns – better management of investment pool
• Separation – allows for the separation of the family business from the family’s wealth or surplus holdings
• Centralization of services – can coordinate tax planning; philanthropy and estate planning

This provides an avenue for the entrepreneur to have a holistic view of the wealth. The current owner can decide how the assets will be divided. In the introspection and reality checks, a big question of all children being treated equally arises. Should the ones showing no interest in the business benefit equally with the ones who have shown an interest, haveworked every summer in the family business and continue to build wealth for the family? It’s the difficult but sometimes right decision if we want to instil the right values in our children. Should assets then be structured with a majority to some and minority positions to others? Ideally, during the wealth creation excess assetssuch as properties and investments can be held separately and could therefore be treated differently from the core family business. This makes the inheritance issues easier to deal with and will reduce the inheritance wars. The Family Office creates a structured mechanism to facilitate a reduction in the disputes and distress brought about by money. There should also be agreements that can deal with in-laws and their rights to the asset which outlines an exit price in the event of a death. In such a case, shares can be sold back to the family or to the children based on specific valuation metrics. This protects the family against divorce and non-family members from having the same rights as family members. This is one of the more unpleasant aspects of dealing with a family business but is a necessary evil.

Conclusion

The Family Office has always existed in more informal structures but it is a concept that has surfaced in more recent times as family disputes continue to arise. One of the parent’s responsibilities is to keep the family together and this is relevant in the family business as well, since this togetherness is what builds the foundation for future generations. It is important that these matters are dealt with by the first and second generations because as the blood line thins, the money line thickens.

Our next article will look at how and when to seek exit options. This will include which options are available and how to maximize sales value of a family business. We will also explore the concept of emotional value and how buyers view this.

About the author

mari-smMaria Daniel is EY Caribbean’s Family Business Leader and a Partner in itsTransaction Advisory Service Line. She has over 20 years of experience as a Chartered Accountant and Financial Analyst and has led several high-profile engagements.She has provided clients, from multinational corporations to family businesses, with advice on raising both debt and equity capital as well as strategic options analysis towards maximizing shareholder value. She specializes in business valuations, transaction support services on both the buy-side and sell-side, mergers, acquisitions and divestitures, independent business reviews, restructuring, strategic advisory services and turnaround advisory.

Maria is a Chartered Financial Analyst Charterholder. She is also a Fellow of the Association of Chartered Certified Accountants and holds a BSc. in Economics and Management.

About EY

EY (formerly Ernst & Young) is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

EY Caribbean refers to the Caribbean organization of member firms of Ernst & Young Caribbean Limited, each of which is a separate legal entity. Ernst & Young Caribbean Limited does not provide services to clients.

For further information on this article, or Maria, please contact Rendra Gopee, Partner in charge of the EY practice in the OECS at rendra.gopee@bb.ey.com or Baldwin Alcindor, Audit Senior Manager at baldwin.alcindor@bb.ey.com.

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