Family Businesses - How Do You Avoid Those Costly Pitfalls?

Family businesses come in many sizes, and research shows that they have clearly defined business problems, which frequently are repetitive and avoidable.

Introduction:

Family businesses often do not achieve their full potential or fail due to their inability to handle the mixing of family and business issues. Only recently has the specific topic of family business received detailed attention in Australia. It is an area of considerable potential consultancy growth for external accountants, as well as potential lawsuits for those who are not aware of the fundamentals. This article is written from the perspective of the external accountant, the accountant who provides advice in return for fees.

What is a “family business”:

There is no clearly accepted definition as to what a family business is. Some commentators state that if you feel that you are a family business and that you are accepted as one, then you are one. Others state that a family business is a business whose owners decide not to sell it, but keep it for the sake of the children. Others again use percentage of ownership criteria. Depending upon the definition chosen family businesses also vary in size: from the micro business (involving a parent and a child), to large private companies (like the Pratt Group), and to publicly listed companies (for example the Packer group of companies). A 1997 Monash University study showed that family business represents 83% of all private sector firms, employs more than 50% of the workforce, and represents an estimated $1.2 Trillion wealth, being approximately three times the capitalisation of the entire Australian Stock Exchange listed domestic companies. Statistics show that only 3 in 10 businesses make it to the second generation, and that in the next 10 years 50% of family business wealth will change hands, but that only about 25% of businesses have identified their next CEO.

Why is a “family business” different from “non-family business”?:

As will be seen family businesses have a number of key idiosyncratic issues facing them. These key issues tend to be common to most family businesses, and are in addition to those faced by non-family businesses. An external adviser (accountant, lawyer, etc) should be aware of these key areas and be able to spot them. These key issues are like potholes in a road. It is important to be able to recognise them, be able to avoid them, and if one cannot avoid them one must assist in damage minimisation. Furthermore, assistance should be given so that the business does not hit the potholes again.

What are these key business issues?:

The key business issues (or “recurring potholes”) can be categorised into five main headings and they relate specifically to the nature of the family business itself. Naturally there will always be an overlap, but in general the headings are:

conflict between business and family values:

Families can be described as warm, socialistic and nurturing, whilst businesses as cold, ruthless and hard-nosed. Thus when the two get together, which is what happens in a family business, there is a huge potential for conflict. An example is the owner who states it is good for their child to work in the business, however, a question the family should ask is whether the child is good for the business? In wealthier family businesses the business can afford to carry a poorly performing family member, but there is no such luxury in an unprofitable business.
funding lifestyle, growth and retirement:

Where is the money going to come from for lifestyle, growth and retirement? Usually there is a conflict: take the money now or leave it for retirement? If it is left for later on, will there be enough to live an adequate lifestyle? An example of problems that may occur is whether the children will be able to afford to pay out the retiree(s), without leaving the business short of funds?
governance issues:

Most family businesses, when compared to non-family businesses, are weak in the area of governance, and this includes professional management. Surveys show that family businesses are lacking in many areas, including: functioning boards of directors (including lack of independent outside directors), formal meetings, long-term plans, management structure, performance appraisals on family members. The effect is that a business is not run as efficiently as it could have been. Whilst this may not be of great concern to the owners, that is the family, it may be of great importance to banks, possible buyers, and employee managers.
leadership, management and ownership succession:

Statistics show that a substantial number of business owners will be retiring in the next 10 years. They also show that few businesses have done any planning for a smooth transition apart from making a will, and even then these are basic wills, many of which have not been reviewed for years, if at all. If the succession aspect is not considered (including leadership, management and ownership) it is clear that the transition will not be as smooth as it could have been. Problems that may occur include tax, sibling rivalry, interruption to the business, and litigation between relatives etc, being problems that may have been reduced or eliminated had they been attended to. For example, X who is 68 years of age, is the owner and CEO. He has 4 middle-aged children working in the business, but stubbornly refuses to name the successor, as he believes that the business is his “baby” and none of his children have the ability to be the new CEO. Thus the paperwork regarding the succession has purposely been neglected, as the problem is “too hard”. Needless to say, the accountants and lawyers will do well out of this case, however, it is questionable whether the family will. The accountant and lawyer to the family should be wary here of possible law suits.
relationship between family members:

Rivalry between family members has existed from the dawn of humanity and will continue to do so. It is not different in family business, which is an extension of the family. Examples include the machinations, frequently with Machiavellian undertones, as to who will be the next CEO, or the holder of a particular office?

How can you avoid the above pitfalls?:

In addition to external advisers (accountants and lawyers) being reasonably conversant with a number of compliance and non-compliance areas, they should also be aware of the above “potholes” that typically affect family businesses. They should know how to advise businesses on how to avoid them and what to do if one is hit. Prevention and cure may include referral to another adviser (for example a lawyer, psychologist etc.), preferably experienced in family business.

Whilst the study of family business is well established in the USA and Europe, it is very new in Australia. If you need a contact point ring Cyril Jankoff, chairman of the Australian Family Business Network on 03 9482 5200, or email - on cj@bused.com.au. Cyril Jankoff FCPA, MBA is also a lawyer. He is completing his doctorate in Family Business.
First published: 27 September 2000.
Last updated: 5 October 2005.