The organization of a family council has been seen in recent years as critical to solving one of the biggest problems in family businesses: the need for better communication between those who run the business—the inner circle—and shareholders who do not participate in the business, who are on the outside looking in.
Often when our firm and other advisers to family companies propose a family council, however, we meet stiff resistance from the “ins.” Many owner-managers are zealous in guarding information about their operations, keeping it even from the eyes of shareholders. These firms tend to be closed, secretive, and almost cult-like in some cases, especially when it comes to protecting financial data.
So when we suggest a family council as a means of improving communication, the idea is often received as ludicrous. Before we even get a chance to explain how the council works, the managers assume it makes all family members privy to financial records, perhaps suggesting to them that the leaders are sitting on a gold mine. The “ins” fear the “outs” will start telling them and the board of directors how to do their work, how to shave expenses or cut bonuses in favor of dividend distributions. “Why open this can of worms?” they ask typically. “If everyone knew what was going on...well, who knows?”
Such suspicions and anxieties are not easily defused, particularly when a council is just getting started and the family members have little experience in their roles or knowledge of how a council functions. Under the circumstances, it is surprising that in most instances the inner circle is eventually won over. The process of building trust is gradual. But despite the vigorous dialogue that creation of a council often unleashes, the leaders not only accept the council but embrace it and use it as a source of support.
The healthy functioning of a family council depends on a proper respect for boundaries between business and family and, just as important, an understanding of the council’s relationship with the board of directors. The creation of a council defuses tensions by opening a dialogue between ins and outs, but it can also help solve specific problems simmering beneath the surface, from perceived inequities in compensation of family members to questions about how family assets will be divided in the parents’ estate plan. Three examples illustrate how attitudes gradually change about the usefulness of a council.
Thorp Seed Company
Frank Thorp, past CEO of a fourth-generation, $15-million seed company and large farming operation near Clinton, Illinois, along with his brother, sister, cousin and uncle, had learned about councils from the family business literature and attending workshops on succession planning. Frank Thorp saw how a council could be useful in calming troubled waters in his company.
Over the years, company stock had been distributed to active and inactive family owners—10 people in three generations. In 1993, the current owners were all either over 60 or nearing it. They were making serious plans for a transition in leadership to the next generation. The board, which consisted of five family managers and two outsiders, had interviewed and hired our firm to guide the planning process.
At this point, the inactive shareholders were uninformed and restless. Success in the business hung on weather and a single good harvest of seed-bearing crops a year. Rumors were circulating in the family that a series of poor harvests had led to several break-even years in a row. The prospects for future profit-sharing among all shareholders appeared to be slim.
We learned that the inactive shareholders were suspicious that the company’s officers were awarding bonuses to themselves and others instead of making distributions to them. Several in the younger generation had worked outside the business and complained the “ins” were out of touch with modern management practices. The family was waist deep in misunderstanding and lack of communication. The situation had become a breeding ground for mistrust.
Further compounding the problem was the annual meeting. All shareholders were invited to the meetings, where they were addressed by the principals and were permitted to voice their opinions. However, the meetings seemed to get bogged down with long reports and department-head presentations. Usually little time was left for comments from inactive family shareholders.
We helped set up a family council consisting of the 10 shareholders and facilitated several meetings for the purpose of improving communications and clarifying company policy. Frank Thorp, then the president, attended the first meeting and gave a report based upon a list of concerns that had been presented to him. Some of the matters addressed were: family-managers’ benefits, paid vacations, expense accounts, and the “good ole’ boy” method of running the company versus professionalization.
The leaders of the business were still defensive about this criticism, but they had begun to come around. They had been to several educational seminars and understood it was their obligation to listen to shareholders. In the course of the discussion, the leaders reeled off numbers about the company’s financial situation—almost more numbers, in fact, than the group could absorb in one sitting. While the numbers did not reveal anything new, the open discussion of them did serve to dispel rumors. In some measure, the discussion reassured the non-participants that the leaders were operating the business in an above-board, conscientious manner.
The Thorp family council began meeting regularly and tackling one issue after another. Management was acknowledging the rights of family shareholders, but, even so, some in this group believed their voice in the firm’s decision-making should be larger. They began to speak of their role as almost on par with that of directors. At the council’s request, our firm made a presentation describing the rights and responsibilities of shareholders versus those of directors. This discussion went far toward clarifying the boundaries and also resulted in another gesture to the outsiders. The council recommended to the board that the agenda of annual shareholder meetings set aside time specifically for questions and comments from inactive family shareholders. Additionally, they recommended the company distribute a newsletter to keep them informed of developments in the business.
These two recommendations were adopted by the board, and all seemed to be satisfied. However, the council members did not stop here. At the next meeting they worked to update a stock repurchasing plan for shareholders wanting to cash out. The plan provided a pricing formula to arrive at fair market value for shares to be redeemed. The board made a few changes in the plan but ultimately adopted it. (No one has cashed out yet, but three stockholders are said to be seriously considering the possibilities.)
Another prickly issue addressed by the council was who would be allowed to own company stock. After hours of discussion, they recommended to the board that only lineal descendants of the founder be eligible. Once again, the board adopted the recommendation. Accordingly, buy/sell agreements and estate planning documents were updated to reflect the new policy.
The Thorp Family Council now meets once a year at a state park or resort. Frank says, “Business is brief and we get to play and socialize. Attendance is excellent. Of course, the company pays the bill.”
The meetings did not change the company’s bottom line, but did make shareholders less anxious about what appeared to be the mediocre performance and meager dividend distributions in recent years. Serious issues remain on the table. At present, two co-presidents, one from each main family branch, run the company. The council plans to discuss how the stock is actually distributed among family members, and whether one or another of the two main branches controls the company. In the future, the council also intends to address two other hot issues: the rules that will govern employment of family members, and whether a partnership would be a viable alternative to a single leader in managing the business.
Haberberger Inc.
Frank and Ann Haberberger founded a refrigeration repair company back in 1948 near St. Louis, Missouri. After 10 years in the business, Frank asked his son, Joe, to join as a partner. The business went from repair work to general contracting, and several years later Frank sold it to his son. Joe not only kept the business going but built it into a $22-million company that today employs 160 people and is one of the most respected mechanical-contractor operations in Missouri.
Now Joe and his wife, Mary Ann, are in their late 50s and are beginning to plan for their retirement. Trouble is brewing within the ranks of their family of seven children. After discussing the transfer of ownership with his brother, a financial planner, Joe proposed to his sons that they buy him out. A plan was put on paper and presented to the entire family. There was one significant omission, however: Joe and Mary Ann’s four daughters were not mentioned anywhere.
The daughters had never participated in the business nor been encouraged to do so. Naturally they questioned the equity of the buyout agreement and the process by which it had been formulated. How would they be considered within the family planning process? Joe did not have an answer, so he sought further counsel.
Ultimately, the result of this work was a family meeting and the formal organization of a family council. In this case the council included all family members and their spouses, a total of 16 people. The family board of directors, composed of Joe and his three sons, were present at the gatherings.
As is typical of most initial family meetings, the “outs” expressed their concerns and the managers tried to answer with explanations and facts. Tensions were eased, and each person gradually became more comfortable discussing their feelings and their hopes and dreams for the future of both the family and the business.
The temperature in the room rose substantially, however, when the conversation turned to issues in what we call the “transfer zone.” Essentially, the issue was: What were the four daughters entitled to in the parents’ estate plan? The family council addressed this matter, and, while doing so, found another issue enveloped within it: Who should be able to own stock in the family company?
Of course, the daughters at first saw stock as the equalizer, making the estate plan fair. However, the council discussed the matter and came to another conclusion. The company was in the process of purchasing a new building and site. The council recommended a limited liability company be set up to hold the building and land. The active sons would ultimately have control of the company, but the daughters would have equal interests in the real estate and buildings for 15 years. Then the brothers would buy them out at a price based on a pre-determined formula.
The daughters agreed that the plan was fair. After consulting with legal advisers, the board voted to accept this solution. It added one provision: The daughters would not be allowed to have company ownership unless they became active in the business by the end of the 15-year time frame. Even that requirement was something of a breakthrough, because it suggested that the daughters might one day be allowed to enter the company, for example, if any one of them decided to go back to work after raising her children.
More recently, the council has discussed creating a family foundation to support charitable organizations in their communities and a fund to support the educations of members of the fourth generation. The board voted to do research into the benefits of different forms of foundations.
The overall result of the family meetings is a deeper understanding and appreciation for each person’s position, their individual goals, and their vision of the company’s future. Each family member is now clearer about where they “fit” in the process, and how they can support the family and business system. The cloud of secrecy has been lifted and communication is improving day by day. Also significant, the three sons who run the business are much more comfortable having family meetings.
First-generation partnership
Al Egelseer started Smart Parts, an auto and truck recycling business, in 1963. Shortly after launching the entrepreneurial venture in Hustisford, Wisconsin, Al invited his brother, Don, to join him. About 10 years later their cousin Ron applied for a job and was hired. Today, the division of ownership among the partners is 45, 45, and 10 percent, with Ron owning the smaller share.
Al’s wife, Carol, and their three children, Debbie, 30, David, 29, and Dan, 25, all work in the business. Don’s wife, Rachel, and son, Rod, 27, also work in it. Their daughter, Ginger, 24, was working in the company, but just had a baby and is on leave. It appears she will not return soon, however, and instead, will pursue her other business interests. A second daughter, Leanne, 22, recently graduated from college and is working for a company in Green Bay. Ron’s children have opted for careers in other organizations. So currently eight family members work for Smart Parts, which employs a total of 75 people.
Al and Don are at the age when they must prepare for retirement and a transition in company leadership. Many concerns and issues had been raised, and, like many businesses, they had little notion of a thought process that might be used to handle these matters. The three owners, who together make up the board of directors, asked us to help.
We discovered that the three owners were very open about sharing information with each other, but gave out little to family managers beyond what was needed in their operations. Members of the next generation also felt they had been kept in the dark. Most were at a point in their lives of committing to long-term careers, but Don and Rachel’s daughters were younger and not yet certain about their direction. Their kids, moreover, were making less money than Al and Carol’s. It was clear that some sort of family meeting was vital.
The family went on a retreat to clarify everyone’s goals for themselves and for the company. It provided answers to questions such as: Who is committed to the family business? Who is interested in leading expansion efforts for the company? What compensation can family members earn for their extraordinary efforts and commitment?
At this first family meeting, it was determined that Debbie, David, and Dan (Al and Carol’s children) and Rod (Don and Rachel’s son) were totally committed to careers in the business. Ginger and Leanne, however, felt they were too young to make such a commitment and needed time to explore other opportunities and start raising a family. Once the commitment of the siblings and cousin were determined, certain employment decisions could be made. The council recommended that management adopt a flexible policy that would allow Ginger and Leanne to enter the company, if they wished, later on.
A more urgent issue concerned compensation. Two of Al and Carol’s children, David and Debbie, had been with the company longer, were judged to be more productive, and had more responsibility than their sibling, Dan, or their cousins. David, Debbie, and Rod made more than the other two, and some family members felt the compensation of all the children should be closer together. After a short discussion, members of the family council determined the compensation issue could not be resolved by them. Instead, they assigned a task force made up of the five siblings and cousins to discuss the issue among themselves and come up with a solution.
The younger generation researched the topic, sought the advice of counsel, and discussed their feelings about the data and questions of equity. Eventually, they recommended to the board that pay scales for jobs held by family members be based on industry standards. The same scales would apply to nonfamily employees. Upon reviewing the recommendations, the board accepted the plan.
Although some family members were not totally satisfied with the plan, the process bore immediate benefits. Understanding the thinking behind the compensation plan made it much easier to accept the discrepancies of income levels among people with the same last name. Small changes have already been made to improve the plan. As a result of the task force’s groundwork, future changes in the compensation plan can be handled more expeditiously.
President Al Egelseer realizes the possibility exists for some disagreement about compensation between relatives. However, having the people who are directly involved form a committee to handle the situation fostered an understanding of the challenge of equitable compensation. It also allowed the cousins and siblings to experience the opportunity of working together on a sensitive issue and see how they reacted to one another. Overall, Egelseer believes the results were beneficial for everyone.
Strengthening the store
The councils of all three families continue to work on defining the values they have in common and that they would like to see reflected in the company’s work. These values now provide a foundation for making certain decisions within the company. For example, the Thorps agreed to continue to stress frugality, responsibility, and compassion in their business dealings. This left the outsiders on the board a little confused. Family values seemed to conflict with business values. They requested further explanation.
The emphasis on frugality equated to making decisions based upon the size of the company’s cash position. It meant limiting the borrowing the business was willing to do. This had to be explained to the outside directors, who felt the company needed to invest in new equipment to keep up with competitors growing at the rate of 12 percent a year. Likewise, compassion translated into letting some family employees whose performance was below expectations remain on the payroll. That policy could undermine efficiency and staff morale.
Two manager-directors who were also members of the family council met with the two outside directors for informal talks to explain the family’s position on risk-taking, funding future growth, and family employment policy. The result of these discussions was that board and family council agreed on values that would guide company policies. The Thorp Seed Co. would pursue a policy of slow growth, working toward steady improvement of current profit margins. As for family employees, they would be offered career counseling on how they could improve their performance or find jobs for which they would be better suited.
When it came to future growth, the Haberberger and Egelseer family councils came to a far different conclusion. Members of both councils saw the spirit of enterprise as a positive value and supported their companies’ efforts to grow and expand by acquisitions. In contrast to the Thorps, these families espoused risk-taking as necessary, even while recognizing that it opens up the door to debt.
The two councils also agreed to provide resources for entrepreneurial ventures. The Egelseers saw their talented family members as a foundation on which to build one of the nation’s best auto and truck recycling businesses. They have pledged resources from the core company to benefit the whole family and attend to each person’s business needs as they change. They see this policy as bringing the family closer together.
Family councils are particularly important in firms that have boards with outside directors. Often outsiders are business leaders who have experience only in public companies. They need to be briefed on the values of family shareholders in order to understand how they will affect and influence business decisions. One of the most important functions of a family council becomes keeping the board continuously apprised of values that shareholders wish to guide the company’s strategy and policies.
Communication between the two structures must therefore be free, open, and regular. This can occur through written communications or even casual and informal chats. Sometimes directors serve as council members, and leaders of the family council attend board meetings as observers. In some companies, the two groups come together periodically to exchange ideas.
Conflict is sure to occur when outside directors become so focused on the bottom line and professionalizing management that they disregard what the family cherishes most. Care must obviously be taken when selecting outside director to ensure a “good fit” between their values and the family’s. Those operations in which the council members and the members of the board interact and communicate their goals and ideas appear headed for successful governance.
The Haberbergers and Egelseers do not yet have outsiders on their boards. But the inner circle of those two companies took a big step when they organized a family council and gave the outsiders in the family a voice. The council will be helpful in resolving more complex issues as these companies expand and the number of shareholders grows. This willingness to engage in open dialogue did not give away the store, as they had feared. Rather, the store was strengthened by forging closer bonds among the shareholders.
Mike Henning is a family business consultant and founder of the Henning Family Business Center in Effingham, IL. He is the author of the Family Firm Advisor newsletter, now in its 10th year.