Surviving the 3rd generation family business

Recently, the business pages have headlined issues in a family business that is on its third generation. For those familiar with the topic of family business management, experts say that it is family ownership that defines the family business. The structure and distribution of ownership can have profound effects on business family decisions, especially in its operations and strategies.

Family business corporations essentially go through three main ownership stages:

1. The controlling owner (first generation stage) where one individual exercises total management control of the whole business.

2. The sibling partnership (second generation stage) in which two or more children of the controlling owner have more or less equal management control and ownership.

3. The cousin consortium (third generation stage) in which cousins or the children of the siblings exercise management control of the business and ownership is distributed in more than one generation.

These are the three stages of what is called the “life cycle” of a family firm. Most business researchers have written that more than 90 percent of family firms do not last beyond the third generation. When a business family reaches the third generation and beyond, the increased complexity of ownership can intensify inherent conflicts between emotion-based family values and tax-based business values, leading to friction and dysfunctional behavior among family members.

There are other challenges during the Cousin Consortium or third generation stage.

First, institutional structure needs to be put in place to manage the complexities of the Cousin Consortium company. A family reaches this stage normally only when it has enjoyed success in business and accumulated great wealth. Wealth and the size of a business are important because below a certain threshold of resources, a Cousin Consortium company usually cannot be sustained, particularly when there are several branches of the family.

This is especially true when large numbers of cousins depend upon the business for their livelihood. This growth in the number of shareholders not involved in management but whose rights must be respected introduces a new level of complexity into the family business.

While in the past, decisions could be made on an informal basis among siblings, now a formal structure like a board of directors becomes critical for resolving major issues. Additionally, a formal forum is needed for shareholders to discuss ownership issues. The greater the number of cousins, the greater the complexity of the organization and the more time and energy and resources are required to set up formal structures.

Second, the new system needs to maintain a balance of power among the branches. The most important challenge confronting Cousin Consortiums is maintaining a balance of power among the various branches. For example, when there are more heirs in one branch than another, leading to more managers in that branch, resentment could develop in other branches. The different branches may also choose different types of distribution of ownership. For example, one branch may divide shares equally among the children, while another branch may set up another family holding company.

In order to weld a Cousin Consortium into a single entity, the cousins must appreciate the extent of their differentiation and design leadership and governance structure appropriate to the new conditions.

Third, the seniors must be able to openly discuss and assess one another’s children. There are few topics more sensitive and likely to fuel ancient rivalries among brothers and sisters than the worthiness of their respective children. The seniors must have clear mechanisms in which ownership and governance issues are confronted and procedures worked out for appraising, selecting and training successors from the pool of cousins.

Also, by the Cousin Consortium stage, if the business is stable, then it means it has been professionalized and there will be active involvement by non-family senior executives.

There will therefore be many issues about how the family can retain control. At the same time, attention has to be paid to the challenge of how to retain non-family senior executives if they cannot be motivated by ownership of shares.

I would suggest that a family governance structure should include a family constitution, family council, succession planning and partnership charters. The family must realize that these structures must be formalized and require legal forms.

I have written columns about family business in the past. During my 22 years of teaching in the MBA program at the De La Salle University, I taught a course on Strategic Management where I incorporated family business management because I concluded that an overwhelming number of Filipino businesses are family businesses. I also used to do family business consultancies during that period.

While there is an increased complexity in the family and in the ownership when a family business reaches the third generation and beyond, these challenges can be addressed and surmounted with the right family governance structures.