Managing The Growing Shareholder Base
4th June 2017 Paul Andrews
The increasing number of shareholders over time creates a challenge for many family firms.
As family businesses passes from one generation to the next, there is the inevitability that the number of shareholders will increase. Such an issue can create a challenge for the family and the family business, not least because of the need for communication but also due to the need to manage the individual relationships within the family and with the business itself, with some family shareholders working within the business and some not.
As Howard Hackney, one of the leading family business consultants in the UK explains, “There is a big difference between the creation of a business by an entrepreneur who starts out on a journey with nobody to report to and a third or fourth generation business. Put simply, the founder normally owns all the shares but after a few generations there are likely to be more shareholders and they will all have different needs and aspirations too. This very often leads to conflict amongst the “confederation of cousins” which results in the failure or sale of the business and hence the statistics which show that only approx. 10% of family businesses make it beyond the third generation.”
Take, for example, a business that was set up by a founder that grew into a successful operation and was passed to the second generation equally prior to his death. The two brothers continued to develop the business, and were joint shareholders (50% each). Everything was fine and the brothers worked well together. In their personal lives, the brothers began families with the first having three boys and the second having one daughter.
This example is actually quite common and moving on a number of years the business had continued to grow. The cousins got on well and were all brought up knowing about the family business, the opportunities it provided them as families and the benefits in terms of their lifestyles too. It was as the transition to the third generation that there were challenges and issues that had hitherto never been considered.
As Howard continues, “Most families face the challenge of doing the right thing by their children and want to make sure that they are fair to them all. In this example, the brothers were originally going to follow the lead from their father and provide for the passing of their shares to the next generation equally. That would have effectively resulted in the daughter owning 50% of the business and her cousins owning 16.67% of the business each. When you consider that the eldest son was working in the business as the Managing Director and the daughter was not working in the business, there were questions that arose.”
This scenario is one that is obviously exacerbated as the business gets older and emotionally can be difficult for families to address. There is a clear need to consider the role of the shareholder differently to that of an employee/director and there is a need for all owners to take on their role responsibly. Whilst easy to say, there are complications for the family firm when roles are so closely entwined and some family members are actively involved in the day-to-day operations as well as owning shares, whilst other family members are only shareholders.
In the example above, the family met to discuss the situation and a solution was determined whereby the shares were put into trusts with each branch of the family having their shares put into a trust for them, thereby ensuring that each family branch had equal voting power. A clear distinction was identified between the ownership of the shares and those running the company (the Board) with the shareholders having, in formal constitutional terms, high level rights over matters such as approval of an annual business plan, borrowing over certain limits and new Board appointments.
A dividend policy was also agreed splitting the annual profits between management, the shareholders and the company. Mechanisms were also put in place to create an internal market for shares so that anyone wishing to ‘cash-in’ their shares could do so according to the agreed protocols and valuation criteria. The issue of who could own shares was also discussed and it was agreed that they could only be owned by the direct bloodline descendants of the founders, thereby protecting the family business from any issues in the future arising from divorce, civil partnerships etc.
As Howard continues, “Each family is different and there needs to be recognition of the family needs and wants in determining an approach for the future. Share ownership in the family firm can be a very emotive matter and by going through a process to determine the roles and responsibilities of the shareholders, and determining the role and the involvement of the family is an important process for any family in business to go through. There is no formulaic solution either, as it needs to reflect the drivers and goals of each family. What is right for one family will not work for another.”
Clearly, the challenge of shareholder succession is one that needs to be addressed. Sadly, in many instances, the issue is not addressed prior to a significant event occurring, be it a serious health issue or a death in the family, a time when emotions are raw and time needs to be dedicated to dealing with the family crisis, rather than potentially fighting over who owns what and who can do what in terms of the shares in the family business.
By agreeing appropriate policies and communicating these to the next generation, there are ways to mitigate the risk of conflict and also preventing the family and the family business from suffering due to perceptions of unfairness due to individual shareholdings.
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