Risk Management in Family Owned Businesses

Risk Management in Family Owned Businesses

A family business can be simply described as "any business in which a majority of the ownership or control lies within a family, and in which two or more family members are directly involved" (Bowman-Upton, 1991). In other words, it is a multifaceted, twofold structure consisting of the family and the business meaning that the involved members are both the part of a job system and of a family system (Bowman-Upton, 1991).

Most families seek stability, intimacy, a sense of community, and belonging through the family business (Hess, 2006). On the other hand, whenever family and business are mentioned together, a majority of people think of continuous conflict, competition and contention (Crenshaw, 2005). However, "successful family businesses do not let the family destroy the business or the business destroy the family" (Hess, 2006).

The family-owned businesses are the backbone of the world financial system. According to a number of estimates, more than ninety percent of all business projects in the United States of America are owned by families. Other estimates reveal that sixty percent of all workforces are involved in the family owned businesses. About 30-40% chief businesses in USA are family owned. Similarly, in the United Kingdom, more or less seventy six percent of the major 8,000 companies are either owned or controlled by families. Similar data and figures have been found regarding the family firms all over the world. Hence, in order to understand the world economy, it is essential to have an understanding of the distinctive characteristics of family owned businesses (Vaknin, 2010).

Relationship between Family and Business Systems

The two systems i.e. family and business can overlap that may result in the occurrence of conflicts as each system has its own set of laws, responsibilities and necessities. The family is an emotional system that has its main emphasis on relationships, faithfulness, reliability, love and care. One enters into this system since the time of birth and attains an everlasting membership. The role of an individual in the family bears with it definite tasks and prospects. Besides, families possess unique modes of correspondence, communication and conflict resolution that take years to become perfect. Such styles, however, may be good for family circumstances but might not be the finest means for resolving conflicts in the business (Bowman-Upton, 1991).

On the other hand, the business system is not an emotional one and is based on contract. One can enter in this system only through experience, knowledge and potential. Performance determines the duration of the membership and the rewards are given in the form of material. The roles of business workforce also have particular tasks and expectations just as family members have. The businesses also have unique methods of communication, conflict resolution and decision making (Bowman-Upton, 1991).

Families build, expand, and demolish their business ventures in a generation's time. Even though their businesses bring riches, prosperity, satisfaction, pride and authority; they also bring nuisance, friction, and pungent divisions. History reveals that a number of families have created great businesses, and have destroyed them later. Family disputes have the tendency to demolish a top-notch business. Business quarrels and clashes may also ruin family relationships and break up the ties of love (Scott, 2002).

Challenges/Risks Faced by the Family Owned Businesses

All the business organizations have an exclusive set of confrontations and problems. Similarly, family business has its distinct risks and challenges. Though a lot of these problems are present in commercial business settings, several can be found in a family business. Family business undergoes different stages of development and expansion ultimately. Thus, a number of challenges have to be faced once the subsequent generations take over the business. According to a famous Mexican saying, family owned business can be summed up as "Padre noble, hijo rico, nieto pobre" (Iwan, 2006) meaning "Father, founder of the company, son rich, and grandson poor" (Iwan, 2006). It can be understood as that the initiator puts the efforts and builds a business, the son later occupies it but manages the business poorly enjoying the wealth at the same time, and the grandson takes over a dead business and poured out bank account (Iwan, 2006).

Risk Assessment and Management

Risk Management can be simple described as "the formal process of assessing exposure to risk and taking whatever action is necessary to minimize its impact" (as qtd. In Cotten, 1993). Risk management seeks to provide remedies to any vulnerability faced by the company (Gerber & Feldman, 2002). The issue of risk management is comprised of all the features of the "family office's work, from the investment process to personal security" (Daniell & Hamilton, 2010, p. 211). In order to have a lasting family business, the owners and their advisors must make certain that "asset and risk management decisions are made with the complete understanding of what the family values, has at risk and how those risks can be managed" ("Risk Management for," 2012). It is also important to identify the risks through the process of risk identification that helps in the exposure of various risks (Culp, 2001, p. 210). It enables the businesses to determine the good and bad things that it may encounter in the future (Frame, 2003, p. 134).

In recent years, increasing attention has been given to risk management (Kimball, 2000, p. 3). All forms of personal activities and businesses are affected by risks (Barrese & Scordis, 2003). Therefore, to have an ample knowledge of risk and risk management is indispensable for understanding the modern business and financial scenarios (Dubofsky & Miller, 2003, p. 22). The major question is what makes up a risk management plan in family-owned businesses? Shrewd and smart executive teams are always there to prepare a retort to disasters that might slow down or encumber the continuity in the business. However, a majority of risk management plans are unsuccessful in incorporating one issue that can have calamitous penalties for any family-owned business i.e. The estate plans of the family owners. Issues that involve succession, tax planning and leadership are some of the challenges faced by the family businesses in case the corporate plan are not compatible with the estate plans of the family owners. If there is a failure in managing these issues proactively, a domino outcome can be achieved that may cripple a company on a permanent basis (Erskine, 2012).

Risk management, thus, comprises of the financial and personal aspects of risk which could have a considerable impact on the contentment, comfort and security of individual family members and family members as a complete unit (Daniell, 2008).

Every family-owned business must follow best risk management practices. Firstly, the context establishment containing information regarding strategies, stakeholders and environment of the company is important. The situations that can have an impact on business objectives must be identified. Later, the risk analysis and assessment must be done. In order to manage the identified risks, strategies must be designed. Then the management processes must be implemented and integrated. The competence, productivity and susceptibility of the business must be measured and monitored. In the end, the owners must be presented with the data so that they can take appropriate steps (Bodine, Pugliese, & Walker, 2001). Thus, it is clear that "risk management is more than preventing bad things from happening" (Wallis, 2012).

Emotions

Family problems are a great risk for the family-owned business and can have a great effect on the business. Situations such as divorce, separations, health or financial problems are found to be creating hard and complicated political situations for the family members, particularly those involved in the business set up (Iwan, 2006).

Thus, emotion is the additional aspect as parents, spouses, children, siblings, uncles and aunts, nephews and nieces etc. work in unison. This emotional dimension must be recognized by the individual who manages such a company. In order to make smooth performance of the jobs, the owner of a family business must take necessary objective decisions. It is important to mention here that the emotional eruptions and flare-ups not only impacts the family, business and relationships but clashes and negative feelings among family members also influence the nonfamily employees.

Therefore, it is the responsibility of the manager to keep the internal strife, backbiting and power struggle from hampering the business functions. This is because an emotional environment may persuade the nonfamily employees to support their decisions on family strains. It is really necessary for the smooth running of a family-owned business to not become a warring camp. It is exceedingly important for the entire workforce to understand that only a united and profitable organization may best serve their interests and not particular family members ("Challenges in Managing,").

Lack of formality

The family-owned businesses also face serious risks due to the absence of unambiguous policies and business rules and customs for family members (Iwan, 2006). If informality in a family business is practiced at a higher level, it can ultimately lead to greater legal exposure (Segal, 2009).

Lack of Written Strategy

The lack of formality results in the undocumented or long-term planning. The business suffers a lot if there is a clash between family members and no documents could be produced to solve it. In order for a family-owned business to run smoothly, it is exceedingly important to have all business agreements in black and white including the "buying and selling of shares, etc., salaries and retirement age, dividend policies, limitations on sale of stock, lines of authority, liability of stockholders or partners, job descriptions" ("Challenges in Managing,") etc.

Compensation Problems for Family Members

A family-owned business may also be at risk if the salaries, bonuses, benefits and reimbursements for uninvolved family members are not plainly described and defended. One of the examples could be a situation when business owners feel that giving their children equal remuneration is just and reasonable. In such a situation, siblings who perform more and have more responsibilities in the business but are given the same amount of salaries that is given to the siblings who have fewer responsibilities are usually offended by such a policy ("Challenges in Managing,").

The best approach to handle salaries is to match them to industry guidelines. After determining the standard salary ranges for different jobs and using them as a guide, both family and nonfamily workers could be paid accordingly. Fringe benefits can also be useful in establishing equity among family members. Family members may be calmed down remarkably by offering delayed profit-sharing plans, retirement fund plans, insurance programs and stock purchase programs. Such a policy could also facilitate the family members to build their personal assets ("Challenges in Managing,").

However, as far as the stock ownership for the purpose of risk management is concerned, it should only be limited to direct descendants and not to any in-laws, third parties etc.

Role Uncertainty

The clear definition of roles and responsibilities in a family-owned business is indispensable to avoid any conflicts, issues and risks. There is a probability for the occurrence of conflicts when roles assumed in the family system interfere on roles in the business system or when the pattern of communication and correspondence used in the family system are used in the business system. Sometimes, a problem or issue in the family interests may hamper the business system and vice versa. Parent and child, siblings or spouses may experience clashes when roles assumed in the business system arbitrate the family system. If a husband and wife work as boss and employee at office, it most likely will not be suitable for them as at-home roles. Then again, a role a member has in the family may not work well for him/her in the business (Bowman-Upton, 1991).

Lack of Aptitude and Talent

A family-owned business could also be at risk if unqualified, unskilled and incompetent family members are hired. The real trouble starts when it does not seem possible to fire them even after their inability to work becomes apparent. The emotional pressure is one of the factors why many businesses have to hire relatives who do not have the aptitude or exploitable talent or skill for carrying out the business functions. In such a situation, the best approach for the business owner is to try to cultivate a talent in the unskilled relative so that he/she could contribute to the business. This could be done by provision of special training. he/she could be assigned special projects that could offer him/her an opportunity for the development of required skills. A nonfamily supervisor could be assigned the duty of monitoring of such a relative so that he/she could be transformed into a productive employee ("Challenges in Managing,").

High Turnover of Non-Family Members

Non-family workforces are found to increasingly leave the family-owned businesses when they notice that the family "mafia" will never allow them to progress and grow professionally. Sometimes, the incompetency of management also makes non-family employees resign from their posts (Iwan, 2006). Thus, the high turnover among top nonfamily employees is not an uncommon challenge to family-owned firms. A number of relatives show antipathy towards outside talent and even make things disagreeable and repulsive for nonfamily management ("Challenges in Managing,").

Succession Planning

It is one of the most difficult decisions a business owner seeking retirement will have to make is to find out who will take over the company that has been his/her life's work (Snyder, 2008).

A majority of family organizations lack a plan for handing over the power to the subsequent generation and this absence of succession planning ultimately leads to great political disagreements and partitions (Iwan, 2006). Management succession inside a family can be a good thing from the perspective of all concerned. However, at the same time, it is undoubtedly the most complicated matter most family-owned/family-managed companies face. Sometimes, parents refuse to commit to a succession plan that always signifies that they do not have the intention of stepping down. This is probably because the business characterizes their identity and sense of self-esteem that they cannot even hand it over to their offspring. In some cases, perhaps the offspring are not trustworthy. Whatever the reason, when the older generation is not successful in committing to particular succession planning, the business could be at a risk of declining (Scott, 2002).

If a business founder is not capable enough to develop a succession plan, he/she can bring experts into the process to do so (Scarborough, 2011, p.693).

Paternalistic Mode of Management

A family-owned business may also be at risk because of the centralization of control. Frequently, good management practices that are the requirement of running a business in today's contemporary era are ignored and not employed. Instead, the management is influenced by tradition (Iwan, 2006).

Overly Conservative

The conservative and old-fashioned elderly family members try to protect the status quo and refuse to accept any changes in the family business. In particular, they resist any contemporary and new-fangled ideas and changes that their younger generation proposes. The older family members in the business are found to have a more conservative stance towards the company's economic structure and propensity to select high risk projects (Iwan, 2006).

Communication Problems

As both family and business systems intermingle, the communication problems arise aggravated by role uncertainty, emotions (jealousy, trepidation, resentment) and political divisions or other problems. A number of families place individual concerns before business concerns instead of balancing the two systems (Bowman-Upton, 1991). Making family communication is one of the top risk management strategies devised by the researchers ("Making Family Communication," 2011, p.1). Family business meetings and family council meetings are the main components of an efficient and successful business communication strategy ("Making Family Communication," 2011, p.3).