Restructuring the Family Business
Research about the survival rates of family businesses is extensive. Historic data indicate that fewer than 35% of the businesses pass to the second generation; fewer than 10% pass to the third generation. Very few survive into later generations as financial and talent requirements dilute the hold of the blood line. These statistics highlight the impact of issues unique to the relationships among family members, although they also include various wealth management strategies, e.g. sale, merge, etc.
No study that I have seen compares the non-family, entrepreneurial survival profile to those new companies that grow into family businesses. The failure rates of young companies are, of course, high, and could be independent of family influences. As businesses survive those early years, what are the dynamics that make family businesses different? To what degree do family ties add complexity to enterprise management? Do family members have rights that others do not enjoy?
Family businesses are closely held organizations in which multiple generations, and/or a number of family members serve as employees or are dependent upon the business for financial support. An attempt is made here to illustrate the emotions involved and the constraints imposed by the dramatically different aspects of the decision systems at play.
The research defines and discusses at length the characteristics and inter-relationships of the ownership, the business and the family systems. Conflict surfaces because the metrics within each system differ and are unable, when they overlap, to meet the needs simultaneously of the participants in each system and of the enterprise. For example:
- Shareholders (ownership system), family and non-family, oversee management, create policy and influence strategy through a Board of Directors. Decision models are financially driven.
- Business systems composed of employees, customers, and creditors demand productivity, expect continuous improvements in performance, and are task based. Focus is external.
- Family systems, that contain members of the immediate family and relations dependent upon the business, are based upon emotions, and are designed to support the needs for security, growth and love. Focus is inward.
An individual may be a member of any (or all) system (s). The complexity arises when a decision will result in conflicting metrics. And where you sit affects personal relationships because there is competition for the resources and values of each system.
Individual confidence in the prosperity bubble raised expectations in more segments of our society and became the foundation of the spend/grow/spend/borrow mantra of the period. Now that the bubble has burst, the masks that hid under-performance, excessive leverage, poor management and ill-conceived strategies have also dissolved. Illiquidity, both corporate and personal, is reapplying pressures that lead to fractured relationships. We are, again; forced to ask which came first? The trouble business? The dysfunctional family?When businesses become stressed, the optimist in us calls only for a little more time, a little more money and the problems will be resolved, the pressure relieved. For the easy money period of the 1990’s, the wish was granted. Funds were plentiful, available from lenders who gave only limited concern to the risks involved in the credit; from investors flush with cash from a runaway stock market or a run-up in property values. Growing consumption in all global corners often solved the demand side of the equation. Technology bred productivity improvements, contributed to growth of disposable income and low inflation rates.These systems often demand decisions that destabilize the environment and are at cross purposes. Picture each as one leg of a three legged stool. One unstable leg (system) can upset the foundation upon which the enterprise is built. The picture gets more confused when you occupy the space formed by the intersection of only two systems. There is a tendency to ignore completely the third (unoccupied) system.
Wealth of most families in which operating assets exist is dominated by the value of the business interests. This wealth may be the basis supporting the current lifestyle, is often the substance of many estate plans, and usually contributes to the financial expectations of the off-spring. Families often leverage their personal financial position and build estate plans based upon over valued enterprises. The gap between reality and expectations can cause irreparable harm to family relationships.
A failed family business leaves an extraordinary trail of personal impacts beyond the loss of family wealth. Personal failure, reduced self confidence and self respect, lower stature within the family and in the community, imposed changes in quality of life, questions raised that have no easy answers, are all factors that must be addressed as part of the corporate and personal restructuring that must occur as performance problems with the business begin to dominate the landscape.
Most families that own and manage a business expose their personal assets further, usually as a result of personal guarantees associated with debt financing. This contingent liability is often forgotten until under-performance results in deteriorating collateral values. The prospects are raised that guarantees will be resorted to as a means of partial debt recovery. In an article published in the January 4, 2002 issue of the Wall Street Journal, this risk was quantified. Recovery rates on defaulted loans had fallen to approximately 55% (55¢ on the dollar) from an historical coverage of 69¢. The increased number of cash flow loans accounted for this trend, exacerbated by the economic slowdown. As recovery rates decreased, the risks to personal assets escalated.
There are a growing number of arguments today calling for restructuring the balance sheet and addressing the operations of the troubled business in a timely manner to improve performance. While these arguments may apply to all businesses, they are particularly applicable to family businesses because of their implications related to wealth management.
What are the statistics for the most recent recession? Pre-recession, risks could be managed through exit strategies that favored payments at high multiples of earnings or cash flow (EBITDA). Buyers/Investors appeared with insatiable appetites. Enterprises values peaked. Even sweat equity could often be converted to cash. As companies began to face adversity, the need to rebuild liquidity became apparent. The drive for cash to reduce financial leverage, an absolutely appropriate strategy, also plays havoc with the reported financial condition (balance sheet) as assets are sold and remaining asset values are rationalized more in keeping with market realities. Lower valuations, more selective buyers and less available cash restricted exit opportunities. Similarly, collateral values decreased rapidly.
Family businesses tend to persevere during difficult periods. The family business strategy usually responds to longer term, financial objectives rather than shorter term, market driven metrics. But more is at play. As in the “Wizards of Oz”, courage, wisdom and heart can result in shared visions, breed loyalty and commitment, achieve higher productivity and keep organizations focused. When these characteristics are no longer prevalent (lost leadership through dilution of family interests, poor succession planning or unresolved conflicts), the family asset is in critical condition and demands multifaceted restructuring.
If courage, wisdom and heart are operative, then the systems’ configuration can take on a different and more supportive form.
But, the family business faces some unique challenges. Among them are:
- There is a need for balance among the four (4) systems, i.e. family, individual, equity, business systems.
- Propensity for conflict can be controlled if sufficient money is generated to support all the stakeholders. Choices or sacrifices can be minimized and various agendas can be satisfied.
- The business legacy (successive generations) can continue to breed opportunity.
Our experience with over 100 family enterprises has left us with a number of lessons learned and open questions. We have learned that:
- Businesses do not fail precipitously. Signs of deterioration can be seen long before conditions begin to accelerate down hill.
- Managing transition and change requires actions that may violate family values of loyalty, love, fairness vs. performance, selection.
- Financial difficulties and cash pressures can cause the systems to become unbalanced.
- Weakened family businesses may find the challenge of restructuring insurmountable, limiting the family’s ability to identify and consider alternatives.
Families must serve the needs of the business if the restructuring is to succeed. Sacred projects and “untouchable” members of the family may have to be acted upon. Procedures and controls, often lacking and rejected in entrepreneurial family enterprises, will be important tools for success. Expectations often have to be reassessed and realigned with current realities.
Conflicts among family members escalate and become visible as cash problems surface; dysfunction within the family is often replayed within the business, albeit on a larger stage. Problems in under-performing businesses create family schisms in all but the soundest of families. Animosities and jealousies left unresolved in childhood will reappear as succession issues and tests of power.
Several core questions always surface in these matters: To what degree should family assets be used to support the ongoing, under-performing asset? Is the family emotionally prepared to participate in the sacrifices that will be demanded of other constituencies?How can family barriers to improved performance be removed?
Third party intervention can help to move the process forward, can insert a sense of urgency, decisiveness and focus. Most importantly, the adviser can help to preserve family unity by restoring credibility with all stakeholders.
The restructuring agenda should entertain more than just re-engineering the balance sheet. As the sole element of change, it often represents “good money after bad”. New equity could achieve higher returns in a passbook savings account unless there are true changes in the enterprise. Additional debt adds burden the Company, and risk to the lender. Performance improvements that maximize profitability in a core business are critical.
Enhanced operations may involve downsizing, i.e. exiting unprofitable business segments, consolidating facilities, reducing employment, addressing performance quality and productivity, etc. But the restructuring process demands more. It is a time to rethink the business plan, to identify and invest in the strengths and core competencies of the business, to reposition the company in order to compete more effectively. Weak systems and procedures (e.g. procurement, production controls), poor asset management (e.g. credit and collection policies; inventory controls), timely repairs and maintenance and quality management are examples of areas that left unattended, can undermine the business by consuming cash and alienating customers, vendors and employees. Key to any restructuring of strategy and operations is to ensure that sufficient human and financial resources are in place to implement the plans properly.
In addition to operations, the restructuring period offers a unique opportunity to address capital structure, shareholder needs and compensation policies and programs. Taken together, the elements of a multifaceted restructuring plan, if implemented soundly, will result in a stronger, revitalized enterprise.
Are family businesses different? Do family ties escalate the emotions and impose constraints on management decisions? The responsible party, often the patriarch or matriarch of the family and of the business must not allow the symptoms to go unattended. If the point of possible resolution of the problems is allowed to pass, it will leave the family in disarray and the business under outside influence.
By Gary Brooks, CMC, CTP; BMD Advisors
Gary Brooks, CMC, CTP, (www.bmd-advice.com) is well recognized as a family business and crisis intervention consultant based in New York, and a founding member of the Turnaround Management Association. He serves as Principal of BMD Advisors, 2011 to Present, whilst providing a broad spectrum of consulting services to early stage and mid-market companies. With a focus on guiding enterprise management in building a stable, flexible foundation, and achieving and maintaining profitability, he further develops operating and financial strategies on which to base healthy growth. His Skills/Expertise could be further defined as: Operations & administrative management in complex organizations; financial & strategic advisory to commercial & non-profit enterprises; Interim COO to achieve improvements in performance, & Family Business Adviser. Connect with him on LinkedIn.
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