Matters Column

Understanding a family’s impact on business value

July 24, 2015
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Nearly all family businesses are created with the intention that the business will grow and be successful, generating value for its owners, employees and community, well beyond the lifespan of its founders.

The family ownership group should recognize that, after they retire or move out of the business, the business entity must continue to survive in order to provide for future generations. Because of this, it is important for the family ownership group to view themselves as caretakers of the business with a focus on long-term value maximization and risk mitigation.

With this in mind, the concept of value creation becomes more apparent. In a family business, it is not just about sustaining short-term cash flow but also building continuity in the business where risk is minimized to ensure value is preserved to maintain a family’s legacy and long-term source of income.

While being consumed in the day-to-day activities of running a business, there can be a tendency to lose sight of activities that create value and minimize risk. Slowly, value-eroding activities begin to creep in and threaten the prosperity of the business. Such activities include:

No vision or direction

When a company is experiencing consistent cash flow, it can be easy to take the cash flow for granted and forgo long-term strategic planning. It is during periods of prosperity when the vision and direction should be set and communicated so that, in more challenging times when critical business decisions are needed, all stakeholders are aligned and have a consistent path to follow.

This is especially critical in a family business, where stressful times generate emotions and can lead to conflict in the organization and family. By ensuring family members are aligned with the long-term vision and can react accordingly, potential value erosion can be avoided.

Misalignment of stakeholders

If the exiting generation is heavily focused on the value of their buy-out when they choose to exit, it can lead them to make decisions that are not necessarily best for the business in the long-term. This will often cause conflict with the next generation of family business leadership who are ultimately concerned about sustainability of the business.

How the buyout of the exiting generating is structured is also an important consideration. Over-leveraging the business to fund the transaction can jeopardize the ability to fund growth or capital expenditures needed for the business to be successful. This misalignment can also cause tension with other stakeholders such as banks and employees.

Preferential treatment of family members

In many family businesses, the business is the main employment agent for a majority of family members. Inherently, this is not necessarily a bad business practice. However, if family members are employed but are not adding value or are not proficient in their role, they are depleting valuable resources in the form of payroll and lost potential that could be recognized with the right employee placement.

Preferential treatment can also occur when family members are promoted before other qualified staff, which can ultimately lead to poor morale and high turnover of non-family members.

Family leadership must realize the function of their business is to create continued cash flow, and it should not be a charity for family who do not positively contribute to the value of the business.

Diversion of resources

The unique attribute that leads to the success of many family businesses is often the entrepreneurial nature and creativity of the family business leaders. However, these attributes can often deplete the value of the business if they deploy resources to side projects or projects that do not add value or minimize risk.

As an owner deploys resources to a hobby or a project that is not aligned with the primary business, the resource — money, time, staff, etc. — is not being used to drive value in the core business. Over time, this can lead to lost opportunities and continued value erosion.

Focus on lifestyle and status

Enjoying the results of hard work and effort does not necessarily erode value, but taking excessive payouts to support vacations, luxury purchases or other non-necessity items, especially in times when cash flows are constrained, depletes available resources that should be invested into building the future of the business.

Often family members may feel they are entitled to larger bonuses or to driving an expensive company vehicle, for example. This may be reasonable at times, but the misuse of funds outside of the business can lead to erosion of future business value.

Although a family business can provide financial support for family members, the focus on lifestyle should not supersede the focus on creating a business that continues to be viable for generations to come.

Pride, ego and power

One of the most detrimental things a family member can do in a business is to continue down a path because they have too much pride or ego to admit mistakes. Investing time, energy and money into something that is known to provide little to no value is stealing from value-added activities that will help build business value.

Pride and ego can also impact a family when one member is too concerned about preserving another family member’s pride, choosing to allow them to stay in a role in the business to which the person is not suited.

This behavior can also be exhibited when a family business leader uses their position in a company to place a non-qualified family member in a position above a qualified employee, or ignores input just because “they are part of the family.” Business leaders must be able to acknowledge mistakes and modify thinking that result in negative outcomes.

Poor implementation or execution

In family businesses, decisions sometimes are made following the “that’s how we’ve always done it” mantra and not because it is the best business practice. This can lead to poor implementation of plans and processes, or execution of protocols that are not appropriate for a certain circumstance, and often results from family members in leadership roles who were never employed outside the family business. This can lead to a lack of general business management acumen that is often gained through schooling or work outside the family business. Exposure to other ideas and practices are important for any family member involved in management.

Overall, many of these value-erosion activities can be mitigated by continuously monitoring business activities to ensure efforts are directed toward the most productive, value-add activities. In addition, a family may choose to enlist a board of directors or advisory board that can be tasked with vetting activities and providing advice on issues that have potential to erode value.

With an ongoing focus on long-term, value-add behaviors and controlling value-erosion, a business has the potential to survive and sustain through many generations.

Chris VanBergen, business development, DWH Corp., providing small and mid-size companies with business and financial advisory services, including ownership transition and succession planning, turnaround and restructure. For more information: dwhcorp.com or (616) 233-0020.

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