In the opening stages of my consultation with a business family, a family business leader, usually the CEO, outlines what she or he thinks are the pressing issues facing the family and the business. At times the difficulties as perceived by the family business leadership are not the real problems. Often, as I gather my own data, additional concerns come to the fore. One subject that is often overlooked by family members is conflict of interest. Family members usually do not view any and all investments by shareholders as a conflict of interest. They reserve that term for shareholder involvement in competing companies in the same industry and they apply it to active shareholders, who work in the business and passive shareholders who do not.
When family members apply such a narrow definition of the term, they exclude instances that cause their fellow shareholders to look askance at them. How is it not a conflict, some ask, when a senior family manager in a business owns shares in another operational business? Surely that reduces time, energy and focus spent on the family business and that is a conflict, they maintain. They cite also participation in activities like civic, business, political and sporting bodies that seem to consume the active shareholders and wonder if they are getting the best effort from that family member.
Conflict of Focus
Of course, the manager in question is always quick to point out that his involvement in the other company is limited and does not take away from his focus on the family business. Plus, says the active shareholder, “I am working very hard in the FB for the financial good of all and other shareholders get the same or sometimes better returns than I do. My salary and bonus do not reward me sufficiently and the passive shareholders are out there making their own money in addition to what I am making for them.” As always, there is validity in the two opposing views. Yes, financial compensation is a driving force behind the outside involvements of active shareholders and that is not the whole story.
By virtue of growing up in a business family, some people develop entrepreneurial qualities that have them chafing at the bit to “do their own thing” and not be hamstrung by having to consult with other shareholders. These people often complain to me about the conservatism of their fellow shareholders and the unwillingness to take risk. Here is the thing — a shareholder in a family business is not his own man or woman, free to do as he or she pleases. This applies to both active and passive shareholders. Joint ownership carries responsibilities to attend to the common good.
There are consequences to the FB if active shareholders plunge into activities which dilute their attention, and these impact the financial wellbeing of the FB, and family trust. Passive shareholders likewise should not leverage their participation in the FB for their personal gain. Often, investment opportunities come the way of FB shareholders just because they carry the right last name or because they are privy to business information that they would not ordinarily obtain were it not for their ownership interest in a FB.
Before following any such lead, a responsible shareholder needs to reflect honestly on the source of the opportunity; the impact his or her involvement will have on the business, and come clean with the family. But that is not enough. The family needs to have a conflict of interest policy in place which explicitly covers a host of situations for both active and passive shareholders. These include relationships with suppliers; the exchange of goods and services between companies in which shareholders have an interest; the impact of external activities on the performance of a manager; path for submission and approval of new business and even regular reporting on passive investments. Indeed, I have sometimes recommended the equivalent of an Integrity Commission for families in business together. It hearkens to my belief that in FBs, transparency dispels suspicion and engenders trust.
Consequences and Prevention
There must be repercussions for those who break the rules. If a family has implemented a conflict of interest policy and a shareholder is found in breach, a penalty must be applied. One such consequence is that the offending shareholder is forced to render his shares in the FB subject to the buy-sell provisions. And as always, the aim is to prevent this last-ditch outcome. One way is to financially reward active shareholders appropriately. FBs need to stop underpaying family members in the business, even as they demand more of them. Yet another way is to encourage joint ventures between the FB and family members who have the urge and ability to run their own show.
This serves a dual purpose of fostering that entrepreneurial spirit and growing the FB for the good of all. Additionally, it allows that family member to access the collective knowledge of the family business organization. What is the point of having a family business that has endured for generations and has the scars to show for this if we do not share the benefit of these learning experiences with family members, whether they work in the FB or not? However, a family member cannot simultaneously obtain a salary from the FB and scratch his itch to independently own and operate another business. Even those who subscribe to the narrowest definition of conflict of interest could cede this.