“Planning for Success in a Family-Owned Business” Aaron Warwick FIN 402—Dr. Juli-Ann Gasper 4/29/2002 EXECUTIVE SUMMARY: The topic covered in this paper is the psychological, emotional, and social challenges facing family business owners. Most people in today‟s world understand that operating a business is a very challenging task. However, what many people do not realize is the unique aspect of operating a business that is part of the family. Family business owners face many unique challenges that non-family business owners do not face. Moreover, the entire family of the business is affected by the business itself. As my paper shows, a family business owner should not separate the business from the family. Without the family, there cannot be a “family business.” Likewise, without the family‟s support, there will likely be no business at all. This paper offers many helpful solutions to help control the level of stress within the family and the business of a family- owned company. The paper begins by outlining many of the unique challenges facing family- owned businesses. In part, the paper deals with the stereotypical make-up of a successful entrepreneur. In addition, the paper points out many common problems and scenarios that family business owners will likely encounter. Furthermore, the paper discusses many frequent planning problems that family-owned businesses share. In the final part of the paper, solutions are offered to counter essentially each issue that was discussed in the first half of the paper. Simply put, the paper should leave the reader with a sense of comfort, knowing that there is an answer to these common problems. The research for this paper was conducted largely via Creighton University‟s library website. The most prominent web search engine used was Academic Universe. The only articles that were used for the paper were articles written by credible authors and published in reliable magazines. In addition to Academic Universe, I conducted an interview with my parents, who are family business entrepreneurs. The major findings of the paper include the “personal legacy statement” and the use of proper and effective planning in increasing the business‟s life expectancy. The personal legacy statement is a unique document created by the entrepreneur of a family-owned business, which gives the person an opportunity to influence the business beyond the grave. An example of the legacy statement can be found in Appendix A. Finally, the use of proper planning is the absolute key to being successful in a family-owned business. The number one reason for failure is due to a deficiency in planning. Family- owned businesses must not only plan, but must learn how to plan effectively and efficiently. This paper attempts to provide a family-business owner with the basic ideas and structure needed to overcome the psychological, emotional, and social challenges facing the business, and to plan effectively in order to maintain the business throughout all generations. TABLE OF CONTENTS Introduction……………………………………………………………….. page 1 Challenges Facing Family Businesses………………………………… page 1 Self-Reliance Favoritism Fear of Mortality “All in the Family” Family Business Paradox Failure to Plan Planning for Continued Success……………………………………….. page 5 Family Council Legacy Statement Performance Leads to Promotion Outsiders Stress General Planning Estate and Succession Planning Conclusion………………………………………………………………… page 8 References (Works Cited)………………………………………………. page 9 About the Author…………………………………………………………. page 10 Appendix A (Personal Legacy Statement)…………………………….. page 11 I. Introduction Surviving in a family-owned business is difficult in today‟s world. In fact, only one-third of family-owned businesses survive to the next generation. Even more astonishing is the fact that only 15% of these businesses reach the third generation of the family (Higgins). Despite the high rate of failure, family owned businesses are one of the most important segments of business in the U.S. economy. In the United States, family firms account for 78% of new jobs. Furthermore, these businesses are responsible for 60% of employment and one-half of the gross domestic product (Watson). A family-owned firm, for the purposes of this paper, is defined as any firm that is privately owned by one, or at most, a few individuals. Some of these firms are rather large firms that make significant profits. Many of them may someday wish to “go public.” Others, however, are simply lifestyle firms. In other words, they give the owner(s) the chance to make a living doing something they love to do. For the most part, these firms have less than 500 employees (CFOB). Despite the fact that family- owned businesses have traditionally been dominated by men, American women are now chosen as successors in about 20% of transfers of family-owned businesses (CFOB). Although family firms do have a high rate of failure, there are many family-owned businesses that are very successful and influential, as evidenced by the above numbers. However, in order for a family business to be successful, the owner(s) must be aware that the business faces many challenges that a non-family business does not experience. After recognizing these challenges, family business owners can then focus on ways to make their business successful despite the obstacles. In this paper, I will outline some of the unique challenges and problems faced by family-owned businesses. As the son of a family business owner, I believe that my own experiences and interview with my family will supplement this topic well. After exploring the unique concerns of owning a family business, I will show how these businesses can overcome the obstacles and win the “family business game.” II. Challenges Facing Family Businesses One of the most unique, and often overlooked, challenges facing a family business comes from the psychological makeup of a successful entrepreneur. Few people would argue that entrepreneurs must be special people. While this is certainly true, the psychological characteristics of an entrepreneur could also damage the business in the long-run. A. Self-Reliance According to John Gephart, second vice president of Union Central Life Insurance Company, “[Family business owners] are very inward. They are reluctant to share information. This unwillingness to share the intimate details of their business finances is a detriment to the entire financial planning process” (Higgins). As Gephart points out, owners of family businesses are often extremely private. Due to fierce competition and a high rate of failure, family business owners are hesitant to disclose information with anyone outside of the family. Moreover, the stereotypical owner of a family business is a “rugged individualist.” In an interview with my family, my dad, an entrepreneur of a family business, reiterated Mr. Gephart‟s point. He said, “When we first began the business, we were very hesitant to share our personal information with the banker. Our finances and personal life had always been just that—personal. However, as we began to grow and needed more financing, we realized that we had to open up.” Although an individualistic attitude may be necessary to be successful in small business, the owner must be aware that being overly inward can cause many problems, such as the ones discussed below. B. Favoritism In addition to the problem of self-reliance, a family business owner is also assaulted with the psychological problem of favoritism towards a particular child. In order to be successful in a family business, the owner sometimes has to show favoritism towards one or more of the children. This often results in the exclusion of one or more of the other children who is not suited to run the business. Contrarily, in a non- family owned business, the owners do not have to be concerned with showing favoritism within the company to one or more children. This is often the case because in these businesses, the owner or president is not solely responsible for appointing employees. As a result, favoritism towards one or more children can be very psychologically problematic for a family business owner in comparison to the non-family business owner. Unfortunately, as Gephart notes, “When people are in this type of situation, they tend to avoid it and do nothing” (Higgins). As a result, the family business may experience future problems that could have been solved if the owner had not ignored the problem. C. Fear of Mortality Another psychological problem that can lead to the failure of a family business is the fear of mortality. Often, business owners resist discussing the future of their business because they do not want to face their retirement and eventual death (Henning). Certainly, the fear of mortality is not unique to family business owners. At the same time, the fear of mortality can affect their business in a unique way. In a family-owned business, the only person that plans for the retirement or death of the owner is generally the owner him/herself. Thus, an owner who fears mortality, as most humans do, may try to avoid planning for retirement or death for psychological reasons. As with the other psychological challenges, this obstacle can often be very damaging to the family-owned business. D. “All in the Family” In addition to the unique psychological challenges facing a family-owned business, family firms also experience troubles with keeping the business “all in the family.” One of the most prevalent problems with keeping the business “all in the family” is what Phillip Perry of National Petroleum News labels the “entitlement mentality.” According to Perry, if family members believe that they should have better jobs, perks, and salaries than non-family members, then the business may suffer from the “entitlement mentality” (Perry). Unfortunately for the business, the presence of this mindset may decrease company morale, especially if non-family employees are aware of the attitude (Perry). Moreover, this mentality may be very inefficient for a family-owned business if the “entitled” family members are not useful and productive. Thus, family businesses must be fully aware of the problems caused by the “entitlement mentality.” “I learned very quickly,” said my dad, “that hiring family members was a mistake for our business if not done properly. I hired [my nephew] to help him work through college, and then [my niece‟s husband] expected a job as well. Quite frankly, he was not going to be an asset to the company and I couldn‟t afford to pay him to do nothing. So, I started a policy that from then until I die, a family member outside our immediate family will not be hired at [my company].” Another problem of keeping the business “all in the family” relates to the stress of operating a family-owned business. In a family organization, the usual strains of business are magnified because emotions and misunderstandings get involved more easily than in non-family businesses (Perry). Many times, family members begin to let feelings of resentment build up over time. Unfortunately, these feelings can be problems at home as well. Moreover, in a family business, problems at home can often become problems of the business. Family members may be upset with one another because of a non-business incident. However, they may bring their harsh feelings to the workplace, leading to more serious problems for the business (Perry). During the interview with my family, my mom told me about her experiences of working in the family business. “Your dad needed someone to work in the office in a secretarial position, but he couldn‟t afford to hire anyone. I worked in the office for several months, but things just didn‟t work out well. Your dad and I would have fights about how much money we were spending and how little we were bringing in. We would ride home and argue on the way home and then argue all night. As soon as we could afford it, we hired a secretary and I got a job [outside of the business].” As this example shows, family business owners must be cautious when keeping the business "all in the family." E. Family Business Paradox Yet another problem faced by family business owners is the problem of their children. As Richard Wolfe, an industrial psychologist, points out, creating wealth from scratch produces a "family business paradox" because children of self-made entrepreneurs often develop different personalities, skills, work ethics, confidence levels, and interests than the parent(s) who built the company (Watson). He believes that this is one of the main reasons why "handing down a family business fails at least 50% of the time" (Watson). In many cases, Wolfe's observation seems to be true. In light of this, family business owners must be aware of the social and psychological effects their business can have on their children's development. Such attention could help preserve the family business throughout generations. “I have always tried to instill in you and your sister the values that my parents taught me,” my dad told me. “My dad taught me how to work hard and earn every dollar I make from the time I was a child. That‟s why I always made you and your sister work to earn your money. Whether it was vacuuming the office on Fridays or painting the bathroom over the weekend, I always made sure that you didn‟t get anything for free.” Conversely, family business owners must be careful that they do not push their kids into something they do not want to do. As James Olan Hutcheson and Dan Pryor note in Financial Planning, family business owners must be careful that they are sensitive to their children's "vocation," even if that means they will not take over the family business. Often, parents feel disappointed or hurt when their children have a different calling in life and decide not to take over the family business. This disappointment can lead the parents to pressure their children into the business. When this happens, the children are frequently miserable and the business suffers greatly (Hutcheson and Pryor). Thus, family business owners face the challenge of finding an equilibrium between raising responsible children and pushing them into running the business against their own wishes. F. Failure to Plan Finally, when the family business takes all the above challenges into planning consideration, it is left with a potential planning disaster. Most of the time, the only people who can really plan for the business are the owners themselves. As stated above, however, these owners must simultaneously balance their planning needs with the extreme psychological, emotional, and familial challenges of operating a family business. Consequently, family business owners often reserve little time or energy for planning. As John Gephart believes, the main reason for family business failure is "little or no planning" (Higgins). Family business owners should then spend more of their time planning. This planning, as I will show below, can help family business owners conquer all of their obstacles at the same time. III. Planning for Continued Success The first step in building a successful plan for the family business is to concentrate on winning the psychological warfare of family business. The family is the most important part of the family business--without it, there is no "family business." The psychological aspect of owning a family business is the most damaging to the family, thus it should be dealt with first. A. Family Council One way to help win the psychological war is to establish a "family advisory council" (Henning). This council should be a liaison between family members and the company management team. Moreover, "all family members, spouses and children old enough not to cause a disruption" should be involved (Henning). This council should be responsible for an estate plan and all of its details, which will be discussed below. B. Legacy Statement Another way to help family business owners combat the psychological game is the use of a personal legacy statement (Stein). In general, a personal legacy statement "is not legally binding, but provides the [family business owner] with the opportunity to tell his or her own personal story to the beneficiaries of the estate. For some, the legacy statement can focus on a history of a family business, including the goals and principles upon which it was founded and the ideals upon which the business was managed" (Stein). Of course, the family could also be involved in such a legacy statement if the owner so desires. Whatever the case, the legacy statement allows the owner to see him/herself influencing the business even beyond death. It also allows him or her to deepen the planning process of the business. For an example of a legacy statement, see Appendix A. Together, the "family advisory council" and the personal legacy statement help the family business owner fight against the psychological influences of operating a family business. The council will, among other things, help the owner and family understand the roles of each family member within the business. This can help the family business owner with his or her feelings of favoritism towards children because the children will often be able to express their views and desires in regards to the business. Consequently, the owner will likely discover that children who seem unfit to take over the company are most likely uninterested in doing so anyway. Furthermore, the legacy statement helps the owner deal with the fear of mortality, and helps give a sense of influencing the business beyond the grave. In addition, both the council and the statement force the entrepreneur to share information with others about the business. C. Performance Leads to Promotion Beyond the psychological problems dealt with in the legacy statement and family council, the family business owner must still keep the family happy while operating a healthy business. In order to maintain a healthy family business, the owner must make sure that performance and production lead to promotion rather than family status. In other words, an employee should be promoted simply based on his/her merit. Family membership alone should never lead to promotion. As business consultant Dr. Jerry Kleiman points out, "Careful planning prior to positioning family members in jobs prevents problems later on. Establish clear, written entry criteria, and detailed job descriptions" (Perry). These criteria, of course, help deal with the "entitlement mentality" mentioned above. Family members must understand from the beginning that performance and productivity are more important than family status. If everyone contributes, you can have as many family members as you like working at the business (Perry). D. Outsiders In addition to establishing production and performance standards, family business owners must make sure they are hiring quality non-family employees who participate in decision-making (Perry). By doing so, owners ensure that if they fall ill, remaining employees will be able to make sufficient and competent decisions that family members may not yet be able to make (Perry). In the ancient kingdoms, when a king died, his son would take over. However, if the son was too young to make decisions, as was often the case, another person, who had been previously selected by the deceased king, ruled temporarily. A family-owned business, which is the family‟s “kingdom,” should be no different. These businesses should always have outsiders prepared to guide the business temporarily in cases of disaster. Moreover, outsiders may be able to mediate minor family disputes that attempt to creep into the workplace. Finally, non- family members can often provide fresh and unique perspectives that may be overlooked by the family. E. Stress Another key to keeping the family happy and running a successful business is to simply recognize the stress associated with a family business (Perry). Unfortunately, many family business owners wish to ignore the stress that they or the business causes on the family. Owning a business is undoubtedly stressful and ignoring this fact can be damaging to both the family and the business. As a result, family business owners must attend to their family and their stresses in order to keep the family balanced. Obviously, by recognizing these stresses, family business owners will be able to keep feelings of resentment and issues from home from entering into the business. Even more than simply recognizing the stress caused by running a family business, owners must also foster open communication with their spouse and children. Such communication can help the family combat the issue of forcing a child into a vocation that is not his or her own (Hutcheson and Pryor). Throughout this communication, the child must know that the family relationship is not dependent upon his or her success in the business (Hutcheson and Pryor). Moreover, if the child does decide to work for the business, they should be paid a fair and competitive wage. Many children who move into family businesses find it impossible to leave because they are bringing home a lucrative salary that outside organizations could not match (Hutcheson and Pryor). Instead of paying children outrageous salaries, the business could give them money or stock via a blind trust that cannot be touched for several years (Hutcheson and Pryor). These suggestions should help the children make the right decision of whether they should work for the business or work elsewhere. F. General Planning Finally, in addition to the above planning, businesses should take advantage of general planning. James Olan Hutcheson and Lee Colan give several tips in Financial Planning that can help a family business. First, family businesses should focus on a target market. A recent German study found that the most profitable companies sold fewer products and had fewer customers and suppliers. The old 80/20 rule, which states that 80% of a company‟s business comes from 20% of its customers seems to be significant, especially for family businesses (Hutcheson and Pryor). Accordingly, these businesses should try to define and target their most profitable market. Family businesses should also select and train their employees rigorously. This training ensures that all employees understand the business, the cost/revenue drivers, and how they can contribute to the financial success of the business (Hutcheson and Pryor). This can also help the family business with another important tool: designing the company culture. In sum, the company culture is created and reinforced by rules and policies, goals, rewards, staffing, training, leadership, communications, environment, and structure (Hutcheson and Pryor). Family business owners can greatly shape their company and its future by establishing a culture that is fitting to their needs and desires. G. Estate and Succession Planning Finally, family businesses must use estate and succession planning to ensure their future viability. As mentioned above, the "family advisory council" can help a family business owner create an estate plan. A "solid plan includes a living will; durable power of attorney; buy-sell agreements; proper insurance protection and an emergency plan; wealth protection such as trusts or guardians for heirs' estates; special bequests; and fair distribution of the senior generation's assets" (Henning). A good estate plan is a great step in the general planning process. However, as Henning notes, "having a will and a couple of trusts" should not be confused with having a succession plan. Moreover, a family needs to make sure that they double-insure an owner‟s life insurance. This is necessary for the sustenance of the family and for purchasing the business from the estate of the owner. Many families of family-owned businesses are not aware of the financial burden that is placed upon them when the owner dies. Consequently, when the death of the owner does occur, families find themselves without adequate insurance policies. Thus, family business owners must be sure to include double insurance protection as a part of their estate plan. Succession plans need to be taken care of well in advance of any planned successions. Waiting too long for succession planning can lead from business considerations to family disagreements (Perry). Moreover, succession plans need to consider the personal needs and desires of the founder. "It's not just a matter of what the founder is retiring from," says business consultant Kleiman, "but what is he or she retiring to?" (Perry). Thus, a succession plan should not only include career planning, formal education, learning the business culture, and handling power and privilege (Henning), but should also incorporate what the owner needs and wants after he retires or dies. IV. Conclusion Operating a family business is a challenging task. The owner(s) and family members face unique psychological, emotional, social, and familial problems not experienced by most non-business owning families. Perhaps that is one of the main reasons why so few family businesses are successful. Despite the high rate of failure, family business owners can overcome these challenges by simply planning. They must plan for all of the unique problems in addition to the general planning that takes place in business. As a result, family business owners must often work twice as hard as a normal business executive. However, the fruits of the family business owner‟s labor will blossom twice as large if planted properly. Works Cited Center for Family-Owned Businesses (CFOB). www.cfob.com/fact. 20 April 2002. Henning, Mike. “A plan now keeps it in the family later.” Waste Age. Oct. 2001. Higgins, Barry. “How family business owners think.” National Underwriter. 26 Nov. 2001. Hutcheson, James Olan, and Colan, Lee. “The seven veils creating wealth in a family firm means uncovering some key business truths still masked by post-dot-com euphoria.” Financial Planning. 1 Dec. 2001. Hutcheson, James Olan, and Pryor, Dan. “When „Right‟ is Wrong: When the children of small-business owners are under pressure to join the family firm and ignore their own calling, everyone loses.” Financial Planning. 1 Oct. 2001. Perry, Phillip. “Listen…talk…and plan.” NPN, National Petroleum News. Sep. 2001. Stein, Helene, and Brier, Marcia. “More Than a Feeling: A personal legacy statement allows clients to pass along more than just financial assets to their heirs.” Financial Planning. 1 Aug. 2001. Warwick, Dave, and Warwick, Becky. Interview. 13 April 2002. Watson, Thomas. “The rich 100—succession: Family circus.” Canadian Business. 31 Dec. 2001. About the Author: The author of this article, Aaron Warwick, is a junior accounting major at Creighton University in Omaha, Nebraska. Aaron will spend his summer working for the public accounting firm KPMG LLP. He will also be celebrating his one year anniversary with his wife, Gwen-Joanna. Aaron has also spent the past year as an accounting intern at Lozier Corporation in Omaha and has a cumulative GPA of 4.0. In addition to his education at Creighton, Aaron is the son of a small family business owner. In 1990, Aaron‟s dad began a millworking company named “Warwick Wood Products.” Although this company began as a custom-made woodworking company, it quickly grew and took on other duties. Currently, the company has a close relationship with Pella Windows. In addition, the company is also venturing into such areas as window installation and home construction. Aaron‟s strong respect for his parents and their business venture is what inspired him to write this paper. APPENDIX A—Personal Legacy Statement PURPOSE: The purpose of “Smith Wood Products” (herein referred to as “Company”) is to provide the Smith family with a decent standard of living while taking advantage of the family‟s excellent woodworking skills and hobby. BACKGROUND: The Company was established by Mike Smith in 1969. Mike was the grandson of the well-respected industrial technology teacher, Marv Smith. Marv‟s son, Frank, was also an avid woodworker. Frank worked for a construction company for over 40 years and spent his spare time making various items for people in his wood shop. He spent approximately 20 hours per week on his hobby. Mike Smith spent much of his childhood helping his dad in the wood shop and began making his own fine-crafted items by the age of 13. During the summers, Mike would spend approximately 60 hours a week in the wood shop making products for his friends and neighbors. He quickly learned that he was a superb wood carver and that he could make a profit from his work. In the summer of 1969, at the age of 17, Mike Smith decided to start the Company, with the help of his father Frank. Mike was able to advertise in the local newspapers of the area and pick up business through word of mouth. Once he graduated from high school, Mike decided that he wanted to make running the Company his career. Consequently, he decided that he should concentrate on growing the company to help support his future family. In 1971, Mike was able to secure a loan from the bank to open up a new state-of-the-art shop. With the loan, Mike was also able to put together a catalog that he distributed throughout the region. Although Mike struggled to make a living for several years, he finally got a big break in 1975. During the fall of the same year, Mike finished an iconostasis for a local Eastern Orthodox church. The church, being very pleased with his quality and pricing, informed the Antiochian Orthodox Christian Archdiocese of North America of their satisfaction. After several months of negotiation, Mike was able to secure a contract with the Archdiocese to produce and improve their iconostases throughout North America. This contract forced Mike to hire outside employers for the first time. Since the signing of the contract, the Company has grown tremendously. The Company still maintains its exclusive relationship with the Archdiocese and has secured several other large contracts. Moreover, the Company is still run by the Smith family. Mike has passed on his passion for woodworking to his son, Brad. Mike wishes to pass on his woodworking skills to his heirs and keep the Company within the Smith family for generations. Furthermore, he desires that the Company will continue to donate 10% of all bottom-line profits to charitable organizations. The Company has provided a decent standard of living for the Smith family over the past 30 years and has also preserved Marv‟s love and knowledge of woodworking. The Company hopes to preserve this family tradition for all generations.