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Family business

Keeping it in the family

Mati Nõmmiste Mati Nõmmiste

Owning a family business can sometimes seem like smooth sailing all the way. That’s especially so when we look at an analysis by Family Firm Institute that has operated for 30 years in the US. It suggests that profitability for family businesses is higher in the long term than that of non-family-owned firms, and that family businesses have a higher equity ratio on their balance sheet, which makes them less vulnerable to financial difficulty. But when it is time for the head of the business to retire, a family firm could find itself in crisis.

In Europe, 85% of companies are family businesses. In Estonia specifically, family firms have not been the subject of broad-based study, with the exception of a few final theses and studies done by consultancies. Yet a Praxis think tank study of development trends in SMEs conducted five years ago found that two-thirds of the companies surveyed identified themselves as family firms. Three years ago, an Estonian Family Business Association was founded as well. Yet Estonia lacks a fixed definition of family business: is it a company where one or two family members hold the controlling stake, or must a family business be 100% owned by a family? Praxis went with the first definition for their study, yet their research also dealt with FIEs – sole proprietors. However the term is defined, one thing is certain: it is hard to overestimate the importance of family firms to the health of the economy either in Estonia or elsewhere.

For example, in Europe 60% of private sector jobs are created by family firms and in terms of organisational culture, they stand out for the fact that employees are not let go easily. But family firms face a major problem in their development when succession comes up: How to hand over the running of the firm so that the company remains successful even after the founders retire. The quarter-century-long development of Estonian family firms is at the point now where the first generation of owner-operators will start stepping back. In the following, we give seven recommendations for a successful transition.

1.    Have a definite structure and procedural rules in place

Lack of formal structure and procedural rules is a common problem in family firms. All too often, lines between family members, owner status and corporate management are diffuse. The roles of owner and executive officer are indistinct. Frequently one person is figuratively sitting in three chairs: the board member who holds a majority stake tends to play the role of a second CEO besides the one hired as executive.

It would be good for family firms to draw up a written document clearly setting out the values and vision of the company and defining the duties of the family members in the company. This helps to avoid possible conflicts.

2.    Strong general management is essential

Good governance is the foundation of a company’s sustainability. Among other things, that means that family members related to the company should agree on what will happen if the founder wants to divest their holding, or dies. An agreement between shareholders should also be concluded to determine the manner in which they can exercise their rights.

3.    Effective communication works wonders

The consequence of poor communication could be that small disagreements swell into major conflicts. Setting out a communication policy in specific terms makes it possible to have even emotionally difficult talks. Over our 25 years of business advisory services at Grant Thornton Baltic, we have often seen that problems at companies are rooted in poor communication. The rules for taking decisions also have to be set out in writing: that helps reduce the risk of the wrong decisions being made due to lack of analysis or lack of information (market situation, taxation etc).

4.    Put financial planning on the pedestal

A fairly common mistake is the lack of discipline in money matters: for example, using company funds to pay personal expenses. It is important to draw up a budget and monitor compliance, and also deal with risk management and expense management. Focusing only on increasing sales is wrong. Expenses must be tracked in parallel.

The company must definitely have agreed on a remuneration system that is understandable for everyone – what are the requirements for getting a raise, on what conditions are bonuses paid out, and so on. Remuneration policy that doesn’t reward employee contribution as such but is based on family member status significantly reduces the motivation of non-family-member employees.

Remuneration policies used in family firms was studied last spring by Janika Jaago in a final thesis defended at the University of Tartu’s Pärnu College. Of the 21 family businesses she surveyed, two-thirds remunerated their employees on equal basis and a third said they did not know whether remuneration was equal. One-fifth of the family firms used a differentiated remuneration system for family members.

5.    Strategic vision and planning

Strategic planning should answer the question of when a specific plan is triggered and also envision a crisis plan for the potential realisation of unexpected and negative scenarios. It is also useful to think about different growth opportunities: should growth be organic or does it stem from mergers or through partnerships? Strategic plans should definitely be committed to paper: in small businesses, including family-owned ones, plans all too often are carried around only in the head of the owner(s).

6.    Actively cultivate talent

One of the most important decisions a family firm will make is picking the right future leader of the company. There’s a great deal older and other family members connected to the business can do to develop entrepreneurial spirit in a younger family member. But one must avoid extremes – don’t impress on children that they alone are the only ones who can and must continue the family business.

It would be good to lay down – once again in writing – the rules on what knowledge and personal traits a future CEO should bring to the table, and whether the position could also go to a non-family member.

Training and development of staff should be in the focus consistently. This area is often neglected in very small family businesses, because everyday work simply doesn’t leave time for training.

7.    Ask for advice

Often family businesses may face sensitive topics that can lead to rifts. An out-of-house consultant can help in this regard by seeing things through impartial set of eyes and de-escalating the situation. Even if there’s no problem, a fresh, outside perspective eyes can be beneficial for a company.