Family Business and

Entrepreneurship
BUSM4171 - Topic 3

Ownership of an
Enterprise Built to
Last

Family Business, Third Edition, by Ernesto J. Poza

Copyright 2010 Thomson South-Western
 Learning Outcomes
1. To promote a better understanding of the owner-manager-
family member relationship.
2. To develop a fuller appreciation for the importance of
ownership and the leadership of shareholders in a family-
owned or family-controlled company.
3. To encourage family business leaders to design the
ownership structure in a way that corporate control and
agility are preserved across generations of owners.
4. To promote understanding of the responsibilities of owners
in relation to a family-owned or family-controlled corporation.
5. To develop an understanding of the absolute need to
govern the relationship between family owners and the firm
that is at the heart of corporate governance in the family
firm.
 Ownership
In this topic, Ownership refers to company share
ownership and the corporate control exercised by
shareholders.

Understanding and successfully leading the owners of

the family firm - its shareholders is an essential part
of the CEOs job.

This is certainly the case once the firm stops being

owned by the single, founding entrepreneur, and
ownership is extended to other family members.
 Ownership
Once second-generation family members become
owners (shareholders), some may work in the family
business, while others may not.

Maintaining unity and a realistic assessment of

business and career opportunities among family
members and shareholders in this situation becomes
very difficult.

This challenge increases as ownership is passed to

third and later generation family businesses.
 Ownership
Shareholder disagreements regarding compensation,
dividends, liquidity, return on investment, business
strategy, financial results, the estate plan, and
management succession are often responsible for the
destruction of successful family companies.

If a family business is going to manage with a long term

goal then investment in the following with regard to
ownership is essential:
1. The design and execution of an appropriate ownership
and control structure.
2. The education, access to information, and engagement
of shareholders.
3. The creation of institutions that govern the interaction
between the owners and the firm.
 Ownership
Shares in family managed companies are often less
liquid (or totally illiquid) than those of management
controlled firms.

As such, shareholders in a family company are often

much more dependent on their family business asset,
more so than those in management controlled firms.

If these shareholders feel left out of management

decisions, they may feel a sense of risk in having their
shares controlled by the family management.
 Shareholder Meetings
Shareholder meetings represent one of the best opportunities
to educate owners about their responsibilities and what the
company and its management expect from shareholders.

Shareholder meetings allow for financial, business, and

competitive information sharing and communication on issues
critical to a family business in a proactive manner.

Shareholder meetings represent the best safeguard for

healthy governance of the familys influence on the business,
and vice versa.
 Shareholder Meetings
http://www.youtube.com/watch?v=avrJaynRDxo
At a question-and-answer session with Allied Irish
Banks chairman Dermot Gleeson, an angry shareholder
pelted him with eggs. The country's largest bank raised
its 2009 projection from bad loans to over $4 billion.

http://www.youtube.com/watch?v=-7vXbxSqyE4&featur
e=related
At Wal-Mart's 2005 shareholders meeting, Rob Walton
quickly moved past suggestions for improving the
company's business practices. Will this year's meeting
be any different?
Two Missions: Some Alignment

Ownership: Management:
Return on Invested Competitiveness,
Capital, Family Unity, Growth, Career
Shareholder Value, Opportunity,
Continuity? Profit?
 Educating and Informing
Shareholders
Family shareholders expecting to fulfill their
responsibility of aligning management interests with
shareholder priorities and holding management
accountable need to have a thorough
understanding of financial statements.

They need to be able to make sense of what the

numbers say about the firm and its competitive
condition.

Without this knowledge, family-business

shareholders can become indifferent and impatient,
and can hamper effective operation of the family-
 Responsibilities of Shareholders to the
Company
1. Define and then demand reasonable returns on
shareholder equity or invested assets
. Previous success, high profitability, and good
shareholder returns may lead managers to be less
demanding.
. Satisfying employee goals and expectations, relaxing
on creativity and innovation, and not challenging the
supply chain or competitors may make life easier for
managers, but it is not fair to shareholders and their
invested capital.
. Owners have to be managements conscience in this
area.
 Responsibilities of Shareholders to the
Company
2. Provide the values and principles of doing business
and ensure they remain instilled in the company
Many family-controlled firms continue to be
successful by finding their bearings, their principles,
in the founding values.
These values are passed down from generation to
generation through the owning family.
Owners who share a family history often assume the
responsibility of being the moral controller for the
corporation.
Stewardship of the values and the legacy is clearly an
ownership responsibility.
 Responsibilities of Shareholders to the
Company
3. Define the owning familys strategy and communicate
owning family priorities
Shareholders in a family firm have a responsibility to
tell management, often through the board of directors,
what the familys strategy and priorities are.
Both the economic and noneconomic considerations of
the owning family must be put on managements
agenda, so that outcomes are tailored to shareholders
priorities.
Family business consultants are sometimes brought in
by boards of directors and CEOs of family owned and
family controlled companies to survey, consider, and
work with the owning family to develop a family
 Effective Governance of the
ShareholderFirm Relationship
Just as the interaction between
ownership, family, and management is
the source of what may constitute a
competitive advantage, it is
simultaneously the source of the
biggest challenge faced by family
firms: the effective governance of the
shareholderfirm relationship.
 The Role of the Board
The superior performance in shareholder value relies on the
composition of the board of the company.

Research has found that higher-performing firms are those in

which representation on the board is balanced between
independent directors and family members.

Research has also found, that a moderate presence of family

members on the board provides substantial benefits to the firm,
so the addition of independent members and advisors is not
meant to exclude continuing family participation on the board.

The role of the board is prominent in the governance of the

relationship between a family and its business when the owner
familybusiness interaction is perceived as a positive-sum
dynamic (as opposed to zero sum dynamic).
 The Role of the Board
Because of the boards importance, next-generation leaders
of family companies frequently undertake a critical review of
any restructuring effort involving their board.

They all come back to the idea that a lot of communication

and education needs to take place beyond what is deemed
traditional board work and strategic planning processes,
because of the familys legacy on the board.

The familys identity remains attached to the companys, so if

the company is going to change in order to adapt and grow,
the board composition has to change.
 The Role of Shareholder Meetings, Family
Meetings, and Meetings of the Family Council
Most of the absolutely essential communication, education, and sharing of
financial and strategic information takes place in regularly scheduled
shareholder meetings, family meetings, and meetings of the family council.

This keeps the shareholders involved and fulfills the legal requirement to
recognize the rights of minority shareholders.

In family firms in which the extended family is large and the ownership
structure has not been limited, representative family councils may be a
vehicle for educating and informing family shareholders.

These representative councils or committees of the council, sometimes

referred to as asset boards, can also provide the board with input regarding
the family strategy and develop policies regarding family participation in the
firm.

Family shareholders should be kept in the information loop even if they do not
work in the company or regularly attend family meetings.
 Information, Communication, and
Education of Shareholders
The ability to read and understand a financial statement with a
high degree of comprehension is a must for shareholders.

Shareholders can reach accurate conclusions about what the

financial information means and the managerial actions it
should prompt only with study, perspective from the
experience of others, and information about competitors and
others in the industry.

As part of their financial literacy, owners should also be able to

understand the capital structure of the firm, know debt levels
in relation to owners equity, and therefore be able to gauge
their ability to operate independently or risk influence by banks
and other sources of capital in how they run their business.
 Information, Communication, and
Education of Shareholders
The particularly appropriate measures of profitability for a company in a particular
industry, plus measures of return on invested assets, return on shareholders equity,
return on sales and the growth plan of the above over time are essential to have and
understand.

How a particular companies results compare against those of the competition and
others in the industry is the ultimate guide to how the business is positioned in the
market.

This then influences whether the owners need to warn management, replace
management, or make different capital allocation decisions for the future.

Information regarding the estate plan also needs to be shared with family
shareholders.

Shareholders who are not sufficiently informed and involved can get suspicious and
concerned.
 Ownership Structure: Design and
Execute it
Many family businesses begin as entrepreneurial firms
that exploit the advantages of speed and agility, being
able to change direction in a hurry.

When faced with competition from a large multi national

company that needs 16 levels of approval for a new
product, system, or approach to market, family
businesses consistently win.

Unfortunately a number of these entrepreneurial

companies discover the costs of losing this advantage
when they continue in later generations of the owning
family.
 Ownership Structure: Design and
Execute it
Leaders of enterprises find that distributing voting shares equally
among shareholders often erodes a next-generation owner-
managers ability to lead.

Successors need to manage the business with ample capacity to

lead.

Stock ownership by complicated trusts can also be a problem.

Unlike ownership, the authority to lead is earned rather than

inherited.

Transferring ownership without an eye toward corporate control

makes it more difficult to acquire the authority to lead.
 Ownership Structure and Classes of
Stock
A consequence of successfully transferring the business is that the ever
expanding number of owners naturally makes it more difficult for family
members in the business to manage effectively.

A particular generations ownership structure may not be appropriate for

the next, as such ownership structures do not transfer well across
generations.

One approach to this challenge is to redesign the capital or ownership

structure of the company by recapitalising its stock (e.g., recapitalising
the common stock into two classes: voting and nonvoting). This way the
senior generation can divide the estate equally among heirs in terms of
value, but differently in terms of corporate control.

Phantom stock can also be created in order to provide the incentives for
key nonfamily management to behave like owners.
Phantom stock mirrors the value of regular company stock but does
not dilute the familys actual ownership and has no voting rights.
 BuySell Agreements
Contractual agreements between shareholders and the
company.

Typically used by family-business owners to facilitate an orderly

exchange of stock in the corporation for cash.

Often the primary vehicle through which family shareholders can

realise value from their highly illiquid and unmarketable wealth
company stock.

The most obvious benefit of a buysell agreement is that it

allows some family members to remain patient shareholders
while providing liquidity to family members with other interests
or goals.
 BUSM4171 - Topic 3

Ownership of an
Enterprise Built to Last

SUMMARY p.61