Family-held businesses have long struggled to maintain size and stature through generations. Even with an emphasis on succession and estate planning, families fall prey to changing environments and deteriorating opportunities that eventually level the company along with the private wealth at stake.
In the U.S., a cultural focus on the individual has created a mind-set of dogged persistence and entrepreneurialism that serves as the foundation for a great number of successful businesses. That same disposition, however, can be restrictive when it comes to long-term, multigenerational planning and ceding control to the next wave of the family.
Meanwhile, family businesses in Europe, Asia and South America face similar challenges with a different cultural outlook. Their emphasis is on preserving the business as an extension of the family, with every member of the tree playing a role. This tends to result in legacies that unfold through the business and the family for many generations.
Families that marry the strength of individualism with a more inclusive, long-term mind-set can capture the best of both worlds: They can improve on a traditional foundation with diversified business interests and strategically populate affiliated ventures with members of the extended family. By creating a holding company or private equity firm with a portfolio of companies, families can extend their interests across industries and generations. The results are seen through more opportunities for succession, estate tax planning and the ability to grow a legacy for centuries.
A History Of Success
In the U.S., planning across multiple generations is either avoided or limited to simple succession strategies. Yet history shows this approach falls short, with just 30% of family businesses surviving into the second generation, 12% into the third generation and only about 3% into the fourth generation or beyond, according to the Family Business Institute.
The family enterprise model counters this precedent and represents a paradigm shift in the way most U.S. families think. Traditionally, Americans view the family as an exclusive unit, and they focus on a specific company as the lifeblood of that nucleus. In European and Asian traditions, the family extends to more distant relatives, and the enterprise model creates opportunities for all. This lengthens the family reach and, from a business perspective, provides more pathways to buoyancy as markets reel through cyclical downturns.
A U.S. construction business that survived to the fifth generation—past the common expiration date—serves as an example of a family enterprise that remains vulnerable despite its protracted history. The 130-year-old company is in many ways a success story, as it reinvented itself to survive in a changing environment, according to a recent article in Family Business magazine. However, the venture once had “500 workers slinging sledgehammers and shaping land with steam-driven graders all over the Eastern Seaboard,” notes Family Business. “Today, it employs 35 people … and manages dozens of specialized subcontractors.”
The company provides a better product offering for modern times, perhaps, but it is not an operation that shows significant gains in serving the family’s needs. Consider that given average birth rates, over the course of 150 years a family can produce 450 descendants. A holding company with continuously developing subsidiaries would allow a great number of those descendants to participate in the growth and the returns.
Family business in Europe is synonymous with such long-term, multifaceted vision. These enterprises account for more than 60% of European companies and 40% to 50% of the continent’s employment. Most important, they are geared to stimulate entrepreneurship: “[Family businesses] have a strong enterprise ethic. … They foster entrepreneurial instinct at the family level, often acting as incubators for new companies,” according to European Family Business, an association of family enterprises. “It is of crucial importance to have an operational framework which provides family business owners with the confidence to pass on their invaluable knowledge and entrepreneurial spirit to the succeeding generation.”
This fabric is strong in Italy, Spain and, in particular, Germany, where the average age of major family businesses is around 84 years. One in eight of these German companies was founded before 1870, according to Deutsche Bank.
In fact, a study last year of family businesses in Bonn found that their main management ideals were securing the family business and an orientation toward long-term goals. The result? A powerful set of companies. About 4,400 major family-owned industrial firms with revenues of more than 50 million euros accounted for 43% of all German exports in 2011, according to Forbes magazine.
Tapping Into The Benefits
While most owners and management teams will agree that spreading risk and opportunity across different initiatives is a fundamentally strong approach, making the leap as a family business can seem daunting. It is no easy task to change a mind-set that has prevailed for generations.
The common approach to family business planning is centered on the short term: Families build around the current owners and facilitate the shift of an existing company to the next generation. This linear thinking limits the potential of the enterprise and moves the plan away from long-term strategy. Too many families cede the opportunity to create a plan that not only will bring the business to the next generation, but will also extend it to different areas that allow for greater family participation. The solution lies in a much more comprehensive business and estate planning effort that should be led by advisory teams.
Tactically, families will do best to begin with three crucial questions:
• Who is the family?
• What are the missions of the family and the business?
• What is the core business, and into which industries can it successfully diversify?
The answers are unique to every family and require thorough investigation, consideration and consultation from trusted advisors. Gathering this information can be difficult, but it serves as a crucial guide for implementing a diversified model. Once established, the benefits are many, and include the following:
Succession Planning
When it comes to succession planning, forcing the wrong family members into management roles can destroy relationships and the business. A holding company with a diverse portfolio of subsidiaries, however, creates more opportunity to spread the talent out by matching positions with capabilities and personalities. Fewer square pegs in round holes means a greater likelihood of continued growth for subsequent generations.
In addition, the senior generation often has difficulty yielding control as its tenure comes to a close. Even when they are fully supportive of their heirs stepping into management, they hesitate to back away from their life’s work. Diversification allows elders to move from an operating company into legitimate, meaningful positions elsewhere in the holding company or into another portfolio company, creating a pathway for the younger generation to take charge.
A holding company structure also enables leaders to migrate from a family-managed company to a family-owned and professionally managed company. Bringing in a layer of separation means the senior team can slowly separate itself from day-to-day operations without forcing control onto a generation that is not yet equipped to lead.
Estate Planning
There are myriad variations of estate planning strategies that can be put into play. Some of them apply to any family-owned company, while some only come to light through the enterprise structure. Early-stage ownership is a prime example: When holding companies launch a new entity, the value at start-up is essentially zero. Ownership in worthless shares can be passed on to heirs, and value will accrue as the new company grows. When the shares appreciate over time, the next generation avoids estate tax on the accumulated value.
Exits as part of the estate plan are another challenge that becomes easier with the enterprise model. A potential sale of the core family business generates tremendous discord, but a holding group presents a number of options to create liquidity through a sale of selected assets. These events will not be approached as an endgame, but as a means to promote prosperity and, more important, to keep the family united.
Maximizing Family Participation
When the company extends more lines of business and the family is expanded to include those beyond the immediate circle, the additional strength can be put to work. Individuals generally welcome the opportunity to flourish, and a diversified platform opens more opportunities for members to lead. Participation promotes enthusiasm, enthusiasm promotes growth, and growth keeps the family thriving from one generation to the next.
A family foundation tied to the business, for example, provides an ideal platform for philanthropic relatives to take on leadership roles. Families can always manage private foundations, but creating a central foundation through the business means that families have one repository to pool charitable gifts. They can make a greater impact, raise more through initiatives such as challenge grants, and give resident philanthropists a vehicle with greater depth and breadth.
Minimizing Family Conflict
Holding companies can help families avoid conflict by creating distance between relatives and managers. In single or centralized businesses, on the other hand, rifts in personal and corporate lives can appear when management manipulates family members or when contradictory instructions from loved ones create confused allegiances.
Laying A Foundation
The family enterprise model is not new to the world, but the U.S. temperament has prevented widespread domestic adoption. Without a revelation or a pain point to drive families toward a new solution, the industry has been content to plan in a straight line from one generation to the next.
History has shown, however, that creating a family enterprise helps create an inclusive environment for relatives, provides the most effective succession and estate planning opportunities and solidifies the future of heirs. Along with the guidance of a skilled advisory team, investing energy in a diversified model will enable families to blaze a trail for their legacies and for U.S. businesses as a whole.
Frederic J. Marx is a partner with the law firm of Hemenway & Barnes LLP.
