What makes one family business crash and burn within a generation, while another one flourishes for centuries? Professor John A. Davis, the founder of the 25-year-old Cambridge Family Enterprise Group, has worked with family businesses in 60 countries and has some insights into how to build a strong family business.
The three generation rule
It’s often said that the first generation creates the business, the second grows it, and the third loses it. While Professor Davis says that this is often true, there are three ingredients that will help families avoid this fate. “Number one, a family needs to grow its assets faster than the family and its business can consume them,” he says, pointing out that over time any family will grow in number and experience higher expenditures.
“Second, you have to produce enough of the right kind of family talent to guide the activities of the family,” he says, saying that families can’t be passive owners and expect the business to thrive. “In each generation, a family needs to ask, what roles can family members best fill and where do we need non-family talent.” Families have to develop good owners, managers and board members from among themselves. “If you don’t have abundant assets, but have talented next-generation members, the family still has a good shot at surviving and being successful.”
Third, the family must stay united around the family’s mission and values. “Growth, talent and unity is the mantra of families who create and also regenerate their wealth in later generations,” says Professor Davis.
Good governance
Working with family isn’t easy. How do successful families handle conflict? Professor Davis says the secret is not leaving things to chance. “You need a mechanism in place where the family – small or large – has a way of talking about its interests, goals and issues,” he says. “These discussions can occur formally as well, but scheduling regular meetings with agendas is a more reliable way to ensure you will get the right issues and interests on the table, make decisions and be able to address and resolve problems.”
Every company needs a family rule book, or a family constitution, “which includes policies that specify, for example, under what conditions family members can be employed in the family company, how family employees will be compensated, developed and promoted, and on other themes that can be problems if not regulated.” Professor Davis says that family owners also need a legally binding ownership or shareholder agreement to maintain a sense of fairness, discipline and order. “These can specify how ownership decisions are made, the decisions owners and the board each make, how the business leader is chosen, and the qualifications to be an owner,” he says. “If you want out of ownership, then we’ve got a policy for that too; here’s how we’re going to price the shares of the company and conduct a buyout.”
A board is important. While Professor Davis acknowledges that many small-business owners don’t see the need for a board, he says they should re-think, even if it simply means having an advisory board with a few independent people, such an accountant, that they can call on. A board increases the direction, professionalism and accountability of management; advisers and board members can also ask important questions, or tactfully intervene when the founders are losing their way.
Many problems happen when one generation doesn’t want to give way to the next. Professor Davis says this is a critical error. “You have to turn over the reins in a timely way to maintain the momentum of your company,” he says. “One of the most important reasons second-generation businesses fail is because the founder stayed on too long.”
Leaders who won’t let go can throttle the next generation by not allowing them to develop expertise and business skills. “Often these founders will say: ‘I would step aside, but no one can do this job but me:’ Four out of five times it’s a self-fulfilling prophecy.” Professor Davis says it’s important to give other family members opportunities in a timely way.
What happens if the founder simply doesn’t want to move on? “One, make sure they’ve got a good board in place that can talk to them in a sympathetic way and nudge them towards a transition,” Professor Davis advises. “Number two, they need to give more freedom of decision- making to their family and other leaders in the business.” And three, there must be an emergency plan in place, “because at some point we’re going to get a call that says you’ve got to come to the office because Dad’s gone.”
Not every founder will be open to being told that it’s time to move on, particularly if he or she is still feeling vital and strong. “Sometimes we’ve got a founder who professes wanting to give this company to his kids, but I know in my heart he is never going to let up,” says Professor Davis. “In this case it’s often best to encourage some in the next generation to leave and start their own companies.”
Overall, however, Professor Davis is optimistic about family businesses, pointing out that it’s the world’s most prevalent business type. “One might say this is the most important sector in any market economy,” he says.
To read the full interview with Professor Davis, visit www.wine-business-international.com
