Roots of good practice that will straddle the generations and help good relations to grow

This case was written and co-ordinated by Richard Segal, chairman of the Family Business Council of Southeastern Michigan.

Both sides of a three-generation manufacturing business have been to see the corporate attorney to end their business arrangement. Neither branch of the family wanted to be tied to the other any longer financially. Both sides are willing to either buy or be bought, but neither has the funds to do so, and neither is willing to finance the sale on time. Trust in the family has run aground with no relief in sight.

For ten years the CEO Bill Junior – who was appointed by his father the previous CEO Bill Senior – has been running the group of five companies. Sales have grown ten times in those years and the company has become truly international on both the sales and supply side.

The problem is that they are not making money and have become cash-poor funding the expansion. They have been borrowing against their real estate holdings to generate working capital, but the real estate has a different ownership group than any of the other companies, including the newest – a manufacturing arm owned by the four third generation managing family members. It is swallowing most of that capital. Monies have become completely mixed up between all the companies.

During the growth, other family members of the third and fourth generation were gifted ownership positions in some of the entities in an effort to avoid estate taxes. Now, those inactive shareholders are challenging management and asking for their piece of the profits.

The senior second generation is a group of three brothers, James, William (Bill) Sr, and Stephen – all still alive and "semi-retired." Stephen had no children and his interests have been bought out of all the entities except the real estate where he still owns one third. James and Bill's family branches have divided everything evenly. Each second generation brother has two of their children in management positions and each of those four third-generation managers make the same income and hold the same ownership positions in each of the companies.

Much of the trust has broken down over perks being unevenly used and abused by the active family members. In addition the inactive shareholders (two of Bill Junior's sisters and three of his female cousins) who are being told that the companies are not making any money, have relinquished more trust while they watch the grand lifestyles of their active relatives. The active family members have made a fair and viable offer to purchase the inactive shareholders so that the ownership in the companies will become parallel, but the sisters (in-actives) looked upon the tender unfavourably. Although the offer was fair and genuine, trust took another hit.

Bill Senior is ill and expected to live less than three years. Everyone agrees that it would be mutually beneficial to work out all the differences before his death, but no one can find a solution. Everyone agrees that they would rather not have the courts decide for them, and they are willing to listen to ideas as long as everything remains equal between the branches, or one branch gets bought at fair market value. In spite of the conflicts, all parties remain cordial. What suggestions do you have to resolve the conflicts?

Commentary1
 This enterprise has not been led effectively. To have grown ten-fold in ten years is an average growth rate of about 25%. That rate is difficult to manage well, and the focus was on sales, not the bottom line. Buying out Stephen's interest without considering liquidity options for other family members was short-sighted. There was also a lack of transparency, evidenced by how little ­information has been provided to inactive shareholders.
 
Even though there is a lot that this family has done wrong over the years, it is heartening to see that they remain cordial. The family needs some outside help. The consultant must try to ­introduce changes, including:

Keep the older generation engaged, but shift the ­decision-making to the younger generation. It is the younger generation who must live with the consequences of their decisions.

Begin a process for information sharing with all ­shareholders. Critical to the success of those meetings will be the introduction of as many objective measures as possible. These might include presentations by the firm's accountants or by bank lenders. It is unlikely that a board of advisors or directors could be installed before some goodwill among the parties has evolved.
 
Develop criteria for leadership in the family enterprise. By including family as well as non-family in that process, the data collected will be more valuable to Bill. 

Over time, working together on these steps will create much needed goodwill among the family, so that ownership shifts will be supported by the family and affordable by the business.

Mark B. Rubin, CPA, Founder and Senior Consultant, The ­Metropolitan Group, LLC.

Commentary 2
I would like to meet each key family member (both active and ­inactive) to ask two questions: first: how do they perceive the reality; second, what is their ideal vision, including best outcome.
 
Inactive shareholders present special risks. Active family members get rewarded through regular compensation. Inactives, however, can only earn financial rewards through dividends or the sale of their equity. If neither one of these is likely, inactives are trapped. They have only a legacy. I have seen many family ­businesses with inactive shareholders self-destruct.

I have also seen many other family businesses with inactives survive and thrive – normally with outside help. I suggest two immediate steps: first, disclosure of financial information to all family shareholders; and, second, hiring an outsider who can serve as a day-to-day examiner of the business.

What if the collective best possible outcome for this family business does involve: (1) a split-up, separating the different lines of the business between family branches; and, (2) a cash out of the inactive shareholders? At this point, the family business should hire an independent team of professionals (a lawyer, an accountant, and a business valuation expert). The problem with using the company's existing professionals is that they are often perceived as having allegiances to certain family members.

The professionals must also help each family member ­understand their own current reality, and the best possible outcome. The current reality for inactive shareholders is that they have no right to be cashed out – or even to receive a dividend – so long as the active management shareholders are not receiving excessive compensation and have fairly managed in the business. On the other hand, the current reality for management ­stockholders is that they must run the business in the best ­interests of all ­shareholders. The best possible outcome may be where ­information is shared, compensation and perks are tied to ­benchmarks, and corporate budgets are developed with the ­expectation and obligation that inactive ­shareholders will receive some return on their investment.

Richard C. Bruder is a partner in the law firm of Seyburn, Kahn, Ginn, Bess & Serlin, PC and practices business law in Southeastern Michigan.