How to build a family business that can live through generations..
A business journey evolves from its setup stage to the growth stage and moves forward. It starts when the entrepreneur establishes the business, works on it, and takes it to the next level. Then the family joins in to support and help grow the business multifold.
Challenges Family owned businesses face
These businesses and families face challenges when the new generation joins. There is often a clash between the traditional way of doing business (followed by the founder) and the approach the next generation wants to adopt. The founder may not be ready to let go, while the next generation may not be willing to accept the old ways. There could also be conflicts between siblings on account of wealth or power. The major challenges typically arise in the form of management and operation style, personal ambitions, expenses, ego, or control.
Poor succession planning, lack of trusted advisers, family conflicts, differing visions between generations, and lack of financial education for children are some of the key reasons why 70% of family-owned businesses fail or are sold before being passed on to the second generation, and almost 90% do not make it to the third generation. Great wealth is a privilege, and without a sense of stewardship and responsibility, many wealthy descendants fall prey to ennui and complacency, failing to safeguard family wealth or treat the business with due respect, leading to the disintegration of many family businesses.
How to move past these?
To overcome these challenges, business families need to adopt an approach that reduces the risk of disintegration and helps build a model that can endure across generations. It is important for families to establish a proper structure and define policies and process guidelines that enable them to continue reaping the benefits of their success while creating a multi-generational business model, often described as avoiding the “sleeves to sleeves in three generations” cycle.
Business families should prioritize having an estate plan in place. They need to create a set of private family trusts and asset protection trusts that help hold personal wealth and business interests within a well-structured framework. Personal wealth can be held in respective family trusts, where members can retain their individual assets as well as their share of family wealth (inheritance), which can be transferred into these trusts.
Families can create a “mother” family trust for commonly held assets and separate individual trusts for each family member. Business shares can then be transferred into these trusts, supported by an intra-trust shareholding agreement. This agreement helps mitigate risks of family disputes by addressing potential issues through inbuilt exit rights, valuation methodologies, voting rights, and dividend rights. Such a structure enables the creation of a sustainable, multi-generational business.
By holding company shares within a trust structure, families can avoid potential issues related to control, management, and continuity. Trusts also serve as effective asset protection tools by ring-fencing wealth. In situations such as separations or divorces, a trust structure can help protect the interests of family members. In fact, it is increasingly common for business families to engage estate planning experts when a family member is getting married, to establish a trust that safeguards family assets in a worst-case scenario. This is particularly relevant in India, where prenuptial agreements are not legally enforceable.
Once the trust structure is in place, many ownership- and wealth-related challenges are addressed. The family can then focus on softer, intangible aspects. Questions related to leadership, succession, remuneration, and incentives for family members need to be clearly defined. Families should consider engaging professionals to help draft a family agreement or family arrangement. Depending on the size and complexity, this could take the form of a detailed family constitution or a simpler agreement.
At a minimum, families should establish policies such as an intra-family shareholding agreement, exit policy, voting rights framework, dividend policy, family budget policy, family milestone policy, and guidelines for management and operations.
With the support of well-structured trusts and clearly defined family policies, business families can build enterprises that endure and thrive across generations.
