How to build a family business that can live through generations

Sandeep Nerlekar

The journey of a business evolves from its set up stage, to the growth stage and then moves on. It starts when the entrepreneur sets up the business, works on it and takes it to the next level. Then, his family joins in to help him grow the business multi-fold.

These businesses and families face challenges when the new generation joins them. There are often clashes in the way traditional businesses are run (by the founder) and the way the next gen wants to handle it. The founder is not always ready to accept change and the next gen is not ready to follow older ways. There could be challenges between siblings on count of wealth or power. A major challenge comes in form of wealth or personal ambitions, ego and/or control.

Poor succession planning, lack of trusted advisers, family conflict, different visions between generations, lack of financial education for children are the reasons why 70% of family-owned businesses fail or are sold before they are passed on to the second generation and almost 90% don’t make it to the third generation.

Great wealth is a privilege and without a sense of stewardship and obligation, many rich descendants fall prey to ennui and boredom, failing to safeguard the family wealth or treat businesses with respect which leads into disintegration of many family business.

To overcome these challenges, business families need to adopt an approach which will reduce the risk of disintegration and will help families build a business model that can live through generations. It is important for the family to put up a proper structure and device a policy and process guidelines that can help the family reap the fruits of a successful family business and create a multi-generational business model or as they say sleeves to sleeves in three generations.

Business families should on priority have an estate plan in place. They need to create a set of private family trusts and asset protection trusts which will help the family hold personal wealth and companies under well structured trusts. The personal wealth can be held in the respective family trusts, where family members can hold personal assets and the share of family assets (inheritance) that can move into these trusts.

Business families can create a mother family trust for the commonly held assets and individual family trusts for the individual family members. One can transfer business company shares in the respective trusts and have an intra-trust shareholding agreement.

This agreement will help the family mitigate risks of any family litigation and take care of potential issues via inbuilt exit rights, valuations methodologies, voting rights and dividend rights. This will help the family build a multi-generational business.

By creating a trust structure and holding shares of the companies in the trust the family can avoid potential problems of control, management and continuity of the business. Trust can also be used as an asset protection tool to ring fence the assets.

In a business family, in situations like separations or divorces a trust structure can be used to protect the interest of the family members. In fact, when a member of the business family is getting married it is now a common practice for these families to engage an estate planning expert to create a Trust to protect the interest of their family member who is getting married, so that in a worst-case scenario of a divorce the family assets are protected. Especially because prenuptial agreements are not valid in India.

Once the family has created the trusts structure, the wealth and ownership related challenges are settled and resolved. Now the family needs to address the softer and mind related challenges and questions related to leadership, business succession, family member’s remuneration and incentive etc. need to be answered. Family should consider hiring a professional who can help the family draw a family agreement or a family arrangement. The family can consider having a family constitution or a simple family agreement depending on the family size and assets. Family should have at least these policies in place like intra-family shareholding agreement, exit policy, voting rights, dividend rights and policy, family budget policy, family milestone policy, management and operation family.

With the help of trusts and family policies the family would be able to build a family business that can live through generations.