5.

Value

Create an Owner Strategy to Define Your Success

“What do you mean we can’t pay dividends this year?” Leigh was incredulous. The board of the surfing brand company she and her sisters Sarah and Sharon had founded had just reviewed projected end-of-year performance. This meeting usually celebrated another incremental step forward, with moderate growth, no debt, and significant dividends, which Leigh, Sarah, and Sharon used to support their comfortable lifestyle and charitable donations. This year, however, revenue growth was way up, but profits were down, and Leigh learned that the covenants on the debt taken out by the company to achieve that growth did not allow for any dividends. For the first time, Leigh felt out of control of the company she had cofounded.

How could the founders of a successful company find themselves surprised by its inability to pay them annual dividends? Leigh and her sisters had done many things right in building their business, including eventually appointing an independent board and an outside CEO to help the company reach the next level. But in turning over day-to-day management to the CEO, they also forgot something critical. They assumed that the new CEO would guide the company well, but they failed to clearly articulate the tangible outcomes that they wanted to achieve—and avoid—as owners. That opened the door to the CEO to pursue a business strategy that ran counter to what mattered most to them.

While public companies’ success is usually measured by growth in shareholder value, the same is not necessarily true for family businesses. And that’s one of the best things about family ownership. You don’t have to define success the way that other companies might. You can follow your own path in determining what matters most to you and your family.

This right to define success typically translates into three possible outcomes for the business. You can aim for growth, looking to maximize the financial value of the business. You can seek liquidity, distributing cash flow to the owners to use outside the business. And you can want to maintain control, keeping decision-making authority within the ownership group. You have the freedom to do what you want with your company. No outsider can force you to value revenue growth more highly than, say, offering family members employment in the business. Or choosing to treat employees like family. Or forgoing growth opportunities that don’t sit right with your beliefs. The right to determine what you value is an incredible opportunity and responsibility for owners.

But ensuring that your business produces tangible outcomes that are aligned with your values won’t happen on its own, as Leigh and her sisters discovered. Few family owners describe their sole objective as maximizing shareholder value in the way most business books assume. And for many family business owners, it is not even one of their primary objectives. Yet, the owners are often unclear about what they do want—or want different things. Unless you find alignment you will miss opportunities for growth, fail to retain talented employees, lose control as management fills the void with their own priorities, or sell the business out of frustration.

To avoid those outcomes, your family business needs an Owner Strategy that defines the rules of the game, how you keep score, what winning looks like, and what moves are not allowed. In this chapter, we will discuss how to:

1. Define value in terms of growth, liquidity, and control
2. Articulate a compelling purpose
3. Translate that purpose into specific goals
4. Define guardrails to keep your company from veering off course
5. Communicate your purpose, goals, and guardrails in an Owner Strategy statement

Your Owner Strategy is one of the purest expressions of who you are as individuals, as a family, and as a family business system. It’s your course to chart.

The right to define value: growth, liquidity, and control

Why should you take the time to define clear objectives in your family business? If you fail to do so, you risk losing your raison d’être for being in business together, especially as the business grows and makes the transition to new generations. That path often leads toward the end of family ownership.

So how do you determine what your family values the most? Start by asking three questions that only owners of a business can answer.

Do you want to place any restrictions on the growth of the business?

This first question might seem counterintuitive. Most public companies single-mindedly focus on growing their financial value because that’s what shareholders demand. As a society, we’re used to measuring success that way. But as Bo Burlingham points out in Small Giants, a book that focuses on companies that choose to be great rather than big: “What’s in the interest of the shareholders depends on who the shareholders are.”

As an owner, you might wish to constrain growth by taking off the table any actions that would otherwise make you more money or broaden your global influence but that don’t align with your values. Several companies we have worked with have deliberately avoided growth in favor of creating a strong culture and, like Frederick (the earlier-described man of routine in chapter 1), a sane work–life balance for the owners and management. “We could triple our sales in a year,” one owner told us. “But that would dramatically change all our lives. There’s a lot of stress that comes with growth.”

How much liquidity do you want to take out of the company?

Owners of a business have the right to the residual, the profits left over after all the bills have been paid. It is up to you to decide whether to reinvest those profits or pay them out in dividends. Family businesses exercise this right in different ways, including payouts of 100 percent of the annual profits to the owners and no dividends for decades with all profits reinvested in the company. The right to make that decision rests with the owners, either directly when they are closely involved in decision-making or indirectly through the policies they set for the board of directors.

Are you willing to give up control over decisions?

Owners set the capital structure of the company, that is, the extent to which the company uses outside debt and equity. As owners, you can decide whether to have the company operate only with the resources it can generate internally or to access other people’s money. Many family businesses resist accepting equity capital from outside investors because they want to maintain full control over their decisions. With such control, the owners can make decisions that benefit their family and that an outside investor would rarely allow. For example, the family business might pay its employees well over market compensation. Owners also tend to worry that debt will reduce their control over their own destiny, since borrowing usually comes with rules and restrictions. “It’s one thing to negotiate with my brother and sister, who know how to push my buttons and annoy me,” said the CEO and co-owner of an Australian retail chain, “but I’ll take that any day over having to report back to the ‘suits’ at a bank, with their insane paperwork and bureaucracy.” As a result, this CEO’s company avoided taking on any debt—something many other family businesses do as well.

Through this influence over growth, liquidity, and control, owners shape the company’s strategy. You can define the objectives of the company in purely financial terms (similar to a public company) or prioritize nonfinancial objectives like improving the environment or paying employees above-market compensation. Likewise, you can allow managers to use any (legal and ethical) means that maximize those objectives, or you can take actions off the table because they conflict with your core values. How you exercise this right puts you in the position to create a company that pursues what you most value.

Defining purpose in a business family

Why do you choose to own your business together with family members?

When we ask that question of families, superficial answers sometimes arise: “We need to maintain our grandfather’s legacy.” Others make a financial argument: “It makes better financial sense to pool our assets.” But such answers are ultimately not compelling—they are what we call surface purpose. If your family business is bound together only by a surface purpose, it’s unlikely to last in the long run. It’s not enough to live someone else’s dream or maximize undistributed profits.

You can find a better answer to that question by working with other owners to identify a compelling reason to own the business together. While we like the term purpose, some families prefer to talk about their mission, vision, or values. Whatever terms you use, you need to define your purpose in these ways:

• The purpose should build family unity by making the family proud of their ownership and of their family.
• It should be aspirational, inclusive, and attractive to all generations and the entire family.
• It should encourage family members to spend more time together.
• It should define how you will exercise your right to determine what you value.

If you don’t have a clear—and shared—understanding of your family business purpose, you can start to identify it (or test it) through the lenses of growth, liquidity, and control:

1. Do you own the business together to grow it? You may value growth because it is a path to change your economic situation or it creates jobs and other opportunities for family members. You may see it as a way to broaden your influence over society. The larger the business, the more you can influence the world. Or you may not value growth at all—if it happens, you might think, that’s great, but you might be more than happy with owning a business that stays more or less in place.
2. Do you own the business together to take money out of it? You may see liquidity as a way to provide for the next generation in a way that your parents could not provide for you. You may view it as a mechanism for funding charitable causes that are close to your heart. Or you may see wealth outside the business as something to be avoided, given its potential to corrupt the family.
3. Do you own the business together to have autonomy over your lives? You may want to control your own destiny. Maybe you started the company, or joined it, because you didn’t want to pursue someone else’s dream. Or perhaps you see control as critical to running the business however you see fit. You may value what the business can do for your family. Alternatively, you may not value control at all, as long as the business seems to be on the right track.

There is no right answer to the question of a business’s purpose. Most families find that each generation has its own reasons to stay together as a business family. The subsequent generation then updates these reasons for their own situation, renewing and refreshing the purpose of the business. Through these lenses, family businesses can express their purpose in countless ways.

We admire several companies’ clear sense of purpose. For example, one US-based family business that we work with lost family members in the Holocaust. It deeply values and appreciates that the United States welcomed the family in a time of terrible crisis. Part of the family business’s purpose is to support countries committed to freedom. As a business, it has explicitly decided to invest only in countries with a high score from Freedom House, a US nonprofit nongovernmental organization that advocates democracy, political freedom, and human rights investment in the United States. The company guards its ownership control tightly, as the owners know that an outside investor may not share their political views when making investment decisions.

Mars, Incorporated has set aggressive goals and takes committed actions to improve the lives of people in its supply chain and reduce the environmental footprint of the company. As the company website explains, “Mars has been proudly family owned for over 100 years. It’s this independence that gives us the gift of freedom to think in generations, not quarters, so we can invest in the long-term future of our business, our people and the planet—all guided by our enduring Principles. We believe the world we want tomorrow starts with how we do business today.” That clarity of purpose has led Mars to commit to invest more than $1 billion over several years in the early 2020s to become sustainable in a generation, to focus on improving the well-being of families around the world, and to apply and share its research to create a better world for pets.

Families often capture their purpose in a statement. Here are two examples.

Our family loves and respects this company. It represents the vast majority of the family’s wealth, it is an important source of our income, it holds us together as a family, and it gives us a chance to make some positive contributions to our troubled world. We want our children and our grandchildren to have these same opportunities to benefit from this company.

We deeply appreciate that a family company can contribute to the personal success of the owners. For us, success includes engaging in work that is meaningful and that could provide financial autonomy. Since personal success is unique to each family member, we want the company to support parents and adult “children” to maximize opportunities for healthy development, while guarding against any downsides of family wealth. We are more willing than most investors to compromise current income to meet our goals of helping family members find fulfillment. Nonfamily owners might not share these views. For this reason, we want the family to retain full control of the company.

Does your family business have a purpose? We encourage you to discuss with the other owners and the leaders of the family—including both the current and the next generation and both bloodline and spouses—your purpose in owning the business together. Doing so will not only help you decide why you are in business together but also help you clarify how your family business will define success.

Setting owner goals

Besides helping family members bond as a business family, a clear definition of purpose will also help you make concrete choices about, and see the trade-offs in, how and where to create value. We call these choices owner goals.

Owners must balance their goals when deciding how fast to grow, how much liquidity to take out of the company, and how much control to retain. If you take money from the company’s profits and distribute it, less is available to invest in growth. If you maintain control by avoiding outside debt or equity, you have less money available either to invest in growth or to provide liquidity to the owners.

FIGURE 5-1

Owners might pursue only one of these three goals (growth, liquidity, and control) or some mix of the three. There are trade-offs to all the combinations. In the Owner Strategy triangle depicted in figure 5-1, we have found that most family businesses prioritize a two-goal approach (the circled goals) at the expense of the remaining goal. Which of these three dual choices best describes the goals of your family business? Let’s look at them in detail.

Growth and control

If you value growth and control, you primarily grow through retained earnings, paying low (or no) dividends. You also have low (or no) external equity or debt, since answering either to outside investors or to borrowers requires surrendering some autonomy. When outside equity is taken on, it is often done on a limited basis or through dual-class shares to ensure that the initial owners maintain control.

The owners of a company we know in the construction industry in Asia reinvest the vast majority of their profits back into the company every year, growing through retained earnings. They pay minimal distributions beyond what is required for taxes and have little debt. This approach works for these owners, as they live relatively modestly and want the business to continue on its current path. The board—and especially the nonfamily directors—have sometimes pushed the owners to lever up the company and acquire other businesses in their sector. The owners have been willing to do that to some minimal degree, but they don’t want to lose control by being beholden to banks. They’re quite happy to limit growth to a level at which they retain control. “Slower and steadier” is their motto.

Growth and liquidity

If you value growth and liquidity, you are still focused on expanding but also on paying out money to the owners. You use other people’s money (equity or debt or both) to keep the engine going, giving up some control as a result.

We worked with a business in the fuel industry in Latin America. Ever since its founding almost fifty years ago, the business had grown by reinvesting the majority of its profits into new facilities and stations (the growth-and-control strategy). The owners continued to see much growth potential but were concerned about the long-term threat of disruption in their industry by emission regulations, electric cars, and ride services like Uber. Recently they decided to sell 30 percent of their company to an outside investor. Beyond gaining the benefits of the partner’s expertise, a primary rationale for this move was to take some money off the table to reinvest outside the company. To accomplish these goals of growth and liquidity, the owners sacrificed some control by bringing an outsider into their close-knit family. They have had to contend with a new reality in which their decisions are constrained by the rights they gave to the partner. But the family doesn’t regret the decision, because it agrees that growth and liquidity are the priorities.

Liquidity and control

If you value liquidity and control, you are not as concerned with how rapidly you grow. Instead, you want to produce significant liquidity while maintaining control over decision-making. You probably have moderate to high dividends, low to no debt, and relatively low capital expenditures.

Leigh and her sisters fit this profile as owners of their surf business. They started the business several decades ago as a passion project. Growing the business had never been a priority for them. As long as it maintained the culture of innovation and allowed them to enjoy the financial fruits of their labors, Leigh and her sisters were happy.

____________

We know highly successful family businesses that define their goals in each of these three ways. These are broad strategies, and companies can find a space in between. In defining your goals, you need to understand what you explicitly or implicitly value as owners. Though purpose will remain your high-level statement of intent, revisit how you achieve that purpose through these trade-offs as things change because of external factors like the economy, industry consolidation, and government policies or internal factors like a generational transition, family conflict, and a transition in senior management.

To start refining your owner goals, look at your previous decisions as an owner group. Which of the three approaches best describes how you have acted: growth and control, growth and liquidity, or liquidity and control? Embedded in the decisions that you have made is your current Owner Strategy, which may provide insights into whether you want to change your goals.

Each of the three approaches brings its own issues to be managed. You should make sure that these issues find a place on the agenda in the appropriate room:

• The owners of growth-control companies need to manage the expectations of family members about distributions, since the distributions can only be paid at a level that does not deprive the business of growth capital. We have also seen that these companies often fail to make good use of the owners’ equity. Since most, or all, of the profits are retained in the business, some management teams will pursue new projects simply because capital is available, not because the ventures are a great investment.
• The owners of growth-liquidity companies need to manage the extent to which they are losing control of decision-making to equity partners or lenders. They can do that by paying careful attention to loan and deal terms and by designing governance structures to maximize the owners’ remaining influence.
• The owners of liquidity-control companies need to manage the firm’s rate of growth. If growth is too fast, it will require additional investment, which may not be available, to maintain its pace. If it is too slow, the business’s momentum will be undermined, employees might leave, and the company’s competitive position may erode.

Creating owner guardrails

Aligning your priorities through your purpose and owner goals is a good start, but it’s all just lip service unless you translate them into specific measurements that the leaders of the business can use to make decisions. These guardrails are the final component of your Owner Strategy. Like the guardrails we rely on to keep us driving safely on highways and busy roads, owner guardrails won’t tell you what to do. But they will provide boundaries around standard business strategy decisions (e.g., opening new stores and investing in new machines), allowing some actions and proscribing others.

Owner guardrails will help you ensure that those running the business day-to-day are directing their energy and resources to what you care about most. Clear guardrails enable more effective ownership. With guardrails in place to spell out how owners define success for the company, you can more confidently delegate decisions to directors and managers.

Guardrails are both financial and nonfinancial. Financial guardrails set specific standards of performance to align with owner goals. They identify the right metrics for evaluating performance and the minimum or maximum threshold for each metric. Imagine that your company has a growth-liquidity focus. You should define how you will measure success for both growth and liquidity—what metrics you will use and what threshold you expect the company to exceed. For example, you might define your financial guardrails as a minimum return on equity of 10 percent and a maximum debt-to-equity ratio of two times your earnings before interest, taxes, depreciation, and amortization.

Owners should home in on only a few financial metrics (usually four to six). Doing so provides clear guidance to the company’s leadership while leaving them ample opportunity to determine the best business strategy. These metrics should connect with the three core owner goals. Table 5-1 describes the objectives of the metrics for each goal and provides examples of those metrics.

Nonfinancial guardrails define outcomes for which owners are willing to sacrifice financial performance. These guardrails assess more abstract aspects of the company, for example, the family’s purpose for being in business together and the owner goals. Nonfinancial guardrails provide the rationale for maintaining control over decision-making. For some families, the nonfinancial goals are both part of the glue that holds them together and a means of making the world a better place.

These nonfinancial guardrails typically fall into four main categories:

• Leadership: Does the company need to be led by its owners, even if they are not objectively the most qualified? One family business we worked with believed strongly that only a family member should run the company, even if it meant that the business would grow less quickly. This belief enabled the family to nurture leadership in each successive generation while ensuring that only someone who truly understood and valued the family legacy would be leading the business into the future.
• Business sectors and geographic locations: Are there particular businesses (e.g., tobacco, firearms) or places (e.g., South Africa during apartheid) that the owners wish to avoid investing in or, conversely, are willing to sustain even if the businesses are unprofitable? For example, one family business that started in the steel industry expanded more profitably into new sectors over the years as the steel business waned in profitability. But the family was reluctant to get rid of the steel business, even as it became a drag on its portfolio of companies, because the members believed that steel was an important part of their legacy. It had sentimental value to them that they were willing to pay for.
• Harmony: Will any decisions be made or avoided to preserve family harmony? Some family firms will keep a division or an office open despite its poor financial performance, because it is led by an owner and closing it will upset the broader harmony of the group. Others have a rule that a family member should never report to another family member, even if this rule causes inefficiency.
• Business practices: To what extent are you willing to sacrifice financial performance to align business practices with your values (social, religious, environmental, etc.)? For example, some companies pay higher than market wages or commit themselves to environmental sustainability standards that exceed industry expectations. See the box “Philanthropy and your family business.”

TABLE 5-1

Identifying your nonfinancial guardrails can be one of the most meaningful parts of deciding what you value. By establishing financial and nonfinancial guardrails, you select metrics to help inform major decisions and ensure that your family business continues to truly represent who you and your family are.

Developing your Owner Strategy statement

Finally, to capture and express what you value, owners should create an Owner Strategy statement, a document that articulates your purpose, goals, and guardrails. This statement becomes a sort of credo for your family business. It should answer the three main questions we have worked through in this chapter:

• Purpose: Why do you own your business together?
• Goals: What trade-offs will you make between growth, liquidity, and control to achieve your purpose?
• Guardrails: What metrics and boundary conditions do you need to provide to the board and management to help them understand and implement your goals?

These three questions are highly interrelated. You will find that working on one question will inform your answer to another.

Developing the purpose of your family business should be a shared Owner Room and Family Room activity. Family members who are not owners are affected by your purpose and play critical roles in sustaining it, so involving them in the process will pay off even if it takes more time and energy.

Translating that purpose to goals and guardrails is an activity led by the Owner Room, though you should draw on the expertise and guidance of your board (if you have one) and your executive team. The board’s job is to ensure that management develops and executes a business strategy in line with your Owner Strategy. Even if your family business has not yet developed the Four Rooms, you will still benefit from mapping out the roles and clarifying who to involve in each level of the design of your Owner Strategy.

Philanthropy and your family business

Giving back is a priority for most of the family businesses we know. Primarily, they do so to make the world a better place. Besides that altruistic motivation, many family businesses see other benefits to their social contributions. Among the benefits are these:

• Deepening the family members’ connection to each other
• Identifying and passing down shared values
• Creating a venue to learn about the meaning and responsibilities of wealth
• Developing talent and leadership in the next generation
• Shifting family assets as part of estate planning
• Building pride and purpose in the family business
• Improving goodwill and loyalty with customers, employees, and other stakeholders
• Assessing the capabilities of family members before they move into the business
• Creating an opportunity to contribute for those whose talents lie outside the business

In these ways, philanthropy can help you sustain a multigenerational enterprise. There’s nothing wrong with having several sources of motivation for giving. We believe that society benefits most when the value that people see in giving back goes beyond pure altruism. If the perceived value is core to your objectives rather than peripheral to them, you will be more likely to sustain your philanthropy over time. Moreover, if the nonaltruistic benefits of philanthropy can only be achieved when you execute the benevolent action well, then your acknowledged self-interest is more likely to motivate you to conduct the philanthropy as effectively as possible.

Regardless of your motivation, there are three main avenues for accomplishing your giving goals:

• Family philanthropy: The vehicles that many family businesses set up for giving back are outside the core business. For example, families often form a family foundation, though there are other vehicles, depending on your country (e.g., donor-advised funds in the United States). Some foundations focus on giving grants; others on running programs. Some families endow their foundation by selling shares of the company, while others use dividends to fund their philanthropy. Although donating money is important, don’t forget about the value of your time, expertise, and political capital.
• Corporate social responsibility: Increasingly, family businesses are integrating socially responsible business practices into their core operations. Some companies also have corporate foundations that serve hybrid business and social objectives. And many family businesses have established programs that facilitate employee involvement in the community.
• Impact investing: Many families are looking to harmonize their investment decisions with social goals. For example, if a company is focused on environmental sustainability with its giving, it doesn’t want to invest in companies whose business model is to indiscriminately cut down rain forests. Some family businesses make more active investment decisions, investing in other companies that are explicitly addressing social needs.

Take the time to identify your philanthropic objectives, including how giving back can help you accomplish the goals you set in your Owner Strategy. Then ensure that the resources you are deploying through your family, business, and investments align with those objectives. But be careful. Because philanthropy involves core values, it can also touch on sensitive topics. When a CCC Alliance survey of the more than one hundred members of its network of family companies asked, “In the broad range of family activities where your family office engages, list three activities that create family harmony and three that create dissension,” charitable foundations or philanthropy appeared on both lists.^a

a. Barney Corning and Laird Pendleton of CCC Alliance.

The Owner Strategy statement should be specific enough to help the board and management make decisions that require trade-offs. For example, you might decide to set a 15 percent return on invested capital as a minimum threshold for retained earnings. When the business is expanding, you might then reinvest all the profits back into the business, but as the market matures, you might reduce that investment and increase distributions to shareholders. We have seen several family businesses with liquidity-control goals whose boards are focused on growing the business and cutting the dividends to invest in that growth—not the hallmarks of a liquidity-control strategy. Clarifying goals will help close the gap.

A good Owner Strategy statement should form the basis of a dialogue among owners, the board, and management. Acting as a dashboard that identifies the metrics used to gauge success, the statement helps the owners know whether the business is meeting the objectives they have set, and it spurs dialogue when the business goes outside the established guardrails. Because a good Owner Strategy statement is a living document that owners refer to regularly, it should be revisited whenever there are meaningful changes to the internal or external environment.

In the case of Leigh and her sisters’ surfing business, their mistake was their failure to articulate their Owner Strategy first to themselves and then to the rest of the company. After realizing the gravity of their situation, they ultimately opted to fire the outsider CEO and elevate a veteran insider to the role instead. While the new CEO lacked the outsider’s credentials, they knew that he would ensure a return to a prioritization of culture and creativity over hockey-stick growth. To avoid a repeat experience, they spelled out their Owner Strategy to the company and worked with the board to align the new CEO’s compensation incentives with it.

Defining your Owner Strategy puts you in the position to create a company that accomplishes what you value most. Owning a family business creates an opportunity to choose your ownership adventure. That, after all, is part of the fun of building a family business and an enduring legacy.

Summing up

■As owners, you have the right to define what value you want the company to create, because only you can answer three core questions:

−What restrictions, if any, should be placed on the company’s growth?

−How much liquidity should be taken out of the company?

−Are you willing to give up control over decisions by accepting outside capital?

■An Owner Strategy defines the rules of the game for your business. It consists of three main elements:

−A compelling purpose, which answers the question: Why do you own the business together?

−The goals that you want to accomplish through your shared ownership. While a purpose is aspirational, owner goals are specific outcomes that speak to how you will navigate the trade-offs between growth, liquidity, and control.

−The guardrails you want to place around the company’s actions to ensure your goals are accomplished. Guardrails can be both financial and nonfinancial.

■Capture these three elements in an Owner Strategy statement, which will help ensure alignment between the family owners and the leaders of the company. The statement should be a living document that you revisit when there are major changes to the internal or external environment.