My question concerns a family-owned real estate development company with extensive commercial and residential holdings. It’s been in business for three generations. The company is small in manpower, as it chooses to outsource most of its services. The Gen 3 CEO is the only family member in management. However, the company is owned by many family shareholders. The CEO likes this dynamic just fine! He gives his real-estate-agent daughter and her company all the listings for residential property sales. He gives his commercial-real-estate-agent son and his company all the listings for commercial leases.
The family business has a family council. It is struggling with these conflicts of interest. After all, the CEO has all the power. How do other family businesses and their family councils handle awarding business to family members?
Advisers’ replies:
The situation you describe is both normal and predictable and stems from not having anticipated a most basic question: What are the rules we all agree to play by?
There are many paths that could have led to this predicament. It might have derived from poor planning by the family shareholder group as a whole. Or it could have resulted from not understanding how to establish a family council that works responsibly and authoritatively. Maybe the CEO’s business decisions are made with the best of intentions. More likely than not, a critical tone will only fan the flames. This is not the time for criticism. Rather, this is a time for learning, listening, asking the right questions and defining a common purpose for a most precious enterprise—a family enterprise.
I must acknowledge that I am not an attorney. That being said, your question suggests that the decisions being made by the CEO are unfair but you’re not clear about who is most affected by the unfairness. For the purpose of clarity, let’s assume there are other shareholders beyond the dad, son and daughter—perhaps nieces, nephews, aunts and uncles. I offer these suggestions:
• Don’t make this about the CEO or his children. Lots of business-owning families embrace a philosophy that encourages family to benefit if the work they do is solid and at a good value. Your note omits any mention of the quality of the work being done by the CEO’s son and daughter or the value they are bringing to the party. Are there other equally or better qualified real estate agents among the other cousins? How do the CEO’s children compare to non-family folk in the marketplace?
• Task an ad hoc committee with learning more about family councils and family governance. They could start by reading articles and books and then move on to meeting with a family business adviser and attending conferences such as Transitions. (Two book recommendations: The Family Business Policies & Procedures Handbook by Family Business Magazine and The Family Council Handbook by Chris Eckrich and Steve McClure.)
• The family council will benefit from having a charter and bylaws to reflect ownership philosophies and some measure of accountability. (See the work written by Randel Carlock, Ludo Van der Heyden and Christine Blondel on “fair process.”) If the family council chair is unable to guide the family’s creation and commitment to such documents, an experienced outside expert is absolutely warranted and well worth the investment.
• Once the family council’s charter and bylaws are in place, they should reflect the family’s philosophies about fair process and how real or perceived conflicts of interest are addressed. That said, a wise family business CEO may find it prudent to be hyper-transparent when directing business to a family member who will materially benefit from the transaction.
In many situations where a well-meaning leader’s decisions are out of sync with the expectations of other shareholders, the steps above will open dialogue that will clarify the desires of shareholders and give the family better structures by which to manage such tensions in the future. In the less-common circumstance where the CEO is purposely disregarding the well-being of the whole for the benefit of a few, shareholders may find themselves seeking the counsel of an attorney who can examine whether benefits have been inappropriately shifted away from other shareholders.
It may very well take the family longer to unbundle this challenge of perceived conflict of interest now as opposed to having done so before the CEO’s children were even old enough to be working full-time. But, we’ve worked on hundreds of cases where a family has successfully gone back and addressed an important facet of the family council’s charter they missed earlier.
Have faith. This can be fixed.
Drew Mendoza, Managing Principal, The Family Business Consulting Group
Conflicts of interest don’t have to become conflicts as long as a few key strategies are put into place:
• Do business only with qualified family members. Family service providers must meet or exceed the capabilities of their non-family competition. For example, in this scenario, I would recommend that competitive bids be periodically sought to ensure that the company is acting in the best interest of all shareholders.
• Ensure all family members have equal access. In this situation, the son and daughter of the CEO are benefiting from the company’s business, but it must be made clear how other family members can contribute, either as employees or as service providers. What are the rules of engagement? How will the job be evaluated? How will the family hear of new opportunities to contribute? What are the selection criteria? How will the family know that the family members working for the company are the best ones for the job?
• Get the family council involved. Since there is an active family council, I suggest that they take the lead in determining how the intersection between family and business is managed. The family council should also think critically about any risks that may pop up because of these arrangements and take steps to safeguard against them.
• Be inclusive and transparent. The key to success is transparency and inclusiveness. If the family and company are transparent with the opportunities and inclusive in allowing others to contribute as well, as long as the family members meet or exceed the non-family competition, getting the family involved in the business can be a great arrangement.
• Get the board involved. If there is a board, I highly recommend that they continually monitor the situation to make sure both the family and the company are benefiting from the arrangement, not just those family members directly involved.
Implementing these key strategies will ensure that the family maximizes their contribution to the company, while avoiding family conflict.
Meghan Juday, Director and Family Council Chair, IDEAL Industries; Founder, Family Business Strategy Group
We would like to think that a family in business is so caring that they are “all for one and one for all.” But as a family expands, different individuals, households and branches exhibit increasingly divergent interests. That is why it is so hard to sustain family unity across more than two generations in business. So, when a family remains together into a third generation, it is a confederation: a group of families who have some common purposes and some divergent ones. With so many people, they must create clear rules and policies for how to use their shared resources, to replace informal or unwritten rules. With new people joining the family and growing up in different households, it is to be expected that they need to make policies and expectations more explicit.
In any business, individual agendas differ among the owners. They must create policies that are fair to all the owners. This is especially true of non-majority owners. If you are the majority leader of a business, you are not free to enrich yourself over the rights of other owners. A family CEO is the agent of the owners, and therefore must be accountable to them. Sometimes a family leader takes on more authority than he or she should. In this example, a couple of things are missing. The rest of the family has been delinquent in not questioning or pushing back.
First, the owners are not exercising their oversight as owners. Most families in the third generation have developed policies for family employment, compensation and accountability that ensure they are working for the interests of everyone. In this family, the owners should get together and decide what policies they want to oversee the tendency of the CEO to show preference to his children. They have a right, and indeed a responsibility, to do this.
A second area is conflict-of-interest policies. Every business, not just family businesses, should have such a policy so that an individual—even a CEO—works for the good of the business and not for his own unfair enrichment. For example, a family real estate business cannot have individual owners competing with the family. This example shows dramatically why a family business cannot succeed unless the board or owners oversee the actions of the CEO, and why they need explicit conflict-of-interest policies.
The board of this family, or the group of owners who are de facto the board, should meet and deal with these issues and create fair policies for family employment and conflict of interest, or the business is not long for this world.
Dennis T. Jaffe, Ph.D., Wise Counsel Research
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