The five Cs of generational continuity

Baker Tilly’s Gary Plaster recently sat down with David Specht, Director of the Drucker School Global Family Business Institute at Claremont University. The objective of the meeting was to discuss “generational continuity” within family businesses and the five Cs – a framework - developed by David to help family businesses achieve generational continuity.

Plaster: What is your vision for the Drucker School Global Family Business Institute?

Specht: I have always been driven by the desire to make a significant impact on families who own businesses. The Drucker School Global Family Business Institute offers an exceptional opportunity to achieve this goal. Our programs cater to some of the most influential and crucial businesses worldwide.

The Institute, being the flagship academic institute of the Drucker School, has a vision to attract students and family business members from around the globe. Our programs focus on tackling the challenges and possibilities of family businesses, such as managing the family's reputation, succession planning, innovation, corporate responsibility, governance, finance and sustainability.

We follow Peter Drucker's principles to develop leaders who can run sustainable family businesses that can be inherited by future generations and positively impact society.

Plaster: What are the five Cs of generational continuity?

Specht: As someone who has advised family businesses for many years, I have identified five key elements that are crucial to consider in order to avoid hardship, strained family dynamics and a low chance of business succession. These elements are commonly known as the five Cs:

1. Cash flow
2. Contingency plans for management and ownership
3. Compensation
4. Communication
5. Conflict

While there is no guaranteed recipe that will preserve family relationships and ensure the longevity of a family business, planning for the five Cs can significantly increase the likelihood of successful generational continuity.

Plaster: Why is cash flow so important?

Specht: It is essential for business owners to have a clear understanding of their company's cash flow. Stress testing the operation can determine how it can withstand input cost or price shocks. In addition to the business's cash flow, retiring owners must consider their own cash flow needs and sources. If they have not accumulated assets outside of the business, their retirement will depend on the enterprise's success. This can cause a disruptive attachment to the business and second-guessed decisions by the founders.

Family businesses should assess the following questions from a cash flow perspective:

• Is the business ready to invite other family members back?
• Can the retiring generation generate enough cash flow for retirement without relying completely on the business?

Plaster: What are contingency plans for management and ownership?

Specht: It is important for every business to have contingency plans in place for both its management and ownership. These plans must be documented, communicated and regularly reviewed.

A management contingency plan should identify individuals within the operation who make important decisions and perform crucial duties on their own. There are risks involved when single individuals make important decisions, putting the operation at danger if those individuals were to become incapacitated, pass away or leave the business. Therefore, it is important to recognize these risks and train back-up staff to reduce them. In addition, plans should be taken into account as owners get older and want to slow down.

An ownership contingency plan should establish and clarify the flow of assets in the event of an owner passing away, becoming disabled or retiring. Few businesses have a comprehensive plan in place, despite it being a straightforward expectation. The plan should include conversations about debt assumption and the rights, roles and responsibilities of owners.

Family businesses should consider:

• The knowledge gap between key managers if one were to pass away or not show up to work and somebody had to take their place
• The flow of ownership and how the business would be impacted if an owner were to pass away

Plaster: Why is compensation so important?

Specht: The issue of how to compensate family members is often disregarded despite its constant presence.  When a member of the next generation is invited back into a family business, clarity on their compensation is essential and must be established. A recommended practice is to compensate individuals based on fair market value for the job they do. Confusion and unintentional consequences arise when compensation is combined with gifting or not tied to job performance. Paying siblings or cousins the same amount, despite performing significantly different jobs, almost always results in problematic situations such as entitlement or sentiments of preferential treatment.

Family businesses should consider:

• Is the family members' compensation aligned with the job they perform?
• If a non-family member were to take on the same job as a family member, would their compensation increase, decrease or remain the same?

Plaster: How do successful family businesses ensure proper communication?

Specht: In order for a business to be successful, it is important to create communication guidelines and expectations between shareholders and the families that control the business. However, many businesses fail to do this. To ensure transparency and trust, consistent communication and a platform for shareholders to stay informed and ask questions must be established. Family meetings with well-thought-out agendas and a safe space for questions are essential.

Family businesses should consider the following:

• Is there a place for family members to learn about the business and ask questions?
• What discussions are necessary to shape expectations and prepare the next generation?

Plaster: How should family businesses solve conflict?

Specht: When it comes to conflict in family businesses, it's important to recognize that it's normal for people to have different perspectives. Planning ahead for how to handle conflict is a wise idea, as assuming it can be avoided may leave you unprepared when it arises.

To ensure that your personal relationships remain intact and your business can continue moving forward, it's important to consider the following questions:

• What processes are in place to manage conflict in a fair and organized way?
• What are the potential financial and relationship costs of not having a clearly defined process for managing conflict within the family business?

Plaster: In your opinion what is most important - family harmony or maximizing the return to the family shareholders?

Specht: As a business advisor, my aim is to leave a positive impact on my clients by helping them maintain strong family relationships and perpetuate their businesses. While it is important to reduce taxes, increase returns for shareholders and safeguard assets from potential threats, my ultimate goal is to encourage families to prioritize their important family bonds.

If you are facing strategic challenges in your family business and need counsel, contact our team today.