What Makes an Effective Owner?
Bob Stafford*, a sixty-year-old third-generation CEO of his family’s precision-manufacturing business, was a great leader and one-of-a-kind mentor. Neither of his children was particularly interested in the day-to-day workings of the manufacturing company, so they both pursued their professional interests outside the family business. His daughter, Sue, was a successful pediatrician and his son Paul was finishing his PhD in anthropology and focused on his young family. Even though they knew that someday they would become owners, neither paid much attention to the business their father ran. But when Bob and his wife, Maureen, perished in a plane crash, Sue and Paul immediately inherited 100 percent of the business their father had led. Unfortunately, they had no clue about how to be effective as owners.
Assuming the professional managers knew their business better than they did, Sue and Paul found out the hard way that being unprepared for ownership comes with substantial downsides. Little by little the managers shared less and less information about the company. They also made some significant decisions without the owners’ input, including suspending paying a dividend, citing the need to reinvest more in the company. Only later did Sue and Paul find out that the managers had essentially moved that money into their own pockets through outlandish pay packages. In a final blow, the managers eventually convinced Sue and Paul to sell the “struggling” business to them at a fire-sale price.
It was a tragic ending for the family business that their father had spent his life building. And it’s unfortunately not unusual. Many family business owners feel – and often are – unprepared for ownership. Even those who attend business school don’t learn about what it means to be an effective owner. Most classes look at ownership through the lens of the public company, whose owners are investors, and whose main objective is to buy low and sell high, ideally across a diversified pool of hundreds or even thousands of companies. The role and influence of owners through this lens is minimal, with almost all decision-making vested in the CEO.
A family business is entirely different. Here, owners probably have most of their net worth tied up in the company, along with a lot of their self-worth because of its history and legacy. They are invested in one business rather than investors in many. As we describe in the Harvard Business Review Family Business Handbook, ownership is powerful. It brings with it the right to make choices about almost all aspects of the business. The choices that owners make – either through their actions or their abdication (as with Sue and Paul) – shape the company’s long-term success or failure.
For a family business to last, its owners need to be prepared to play this essential role. The good news is that anyone can be taught to be an effective owner. It doesn’t require an MBA or a law degree. What it does require is a willingness to learn and apply the ownership toolkit.
What constitutes an effective owner?
Through our years of working with family business owners around the world, we have identified 10 competencies that all owners should develop to effectively guide their family business. Note we didn’t say that these competencies are essential to run a family business. One key distinction of family businesses is that ownership is not synonymous with management. Not all owners need to be actively involved in running the business. In fact, it’s entirely possible to be an effective owner without getting involved in its day-to-day activity. But all owners do need to be capable across the following competencies:
- History and values: Research shows that people who understand their family history are more resilient. But this means more than just being familiar with the highlights of how the business grew. What really helps to ground you is what psychologists Robyn Fivush and Marshall Duke call the “oscillating family narrative,” which discusses the ups and the downs that even highly successful families experience. You should seek to be grounded both in the origin story of their family and the business, a deep understanding of how the business has evolved and survived, as well as the values that serve as the North Star for the family’s work together.
- Corporate structures: Make sure you understand how the business is owned and what that means for you. Many family businesses are held through “pass-through” structures like LLCs and S-Corps. In those situations, the company’s taxes become tightly coupled with yours. Don’t expect that TurboTax will be sufficient to fill out your return – you will need high-end advice. And beware of big checks from the company, because some may really be for the tax authorities, not for you to spend. Every corporate structure brings with it different implications for you as an owner, and understanding your own corporate structure can help avoid tax misunderstandings, manage your own liability, and minimize unnecessary risk.
- Estate planning: When you live in a country with estate taxes (as most do), the longevity of your business will be significantly influenced by planning for those taxes. We have found it helpful to think about the government as your business partner, one you can’t ignore and with whom you need to plan. You will need to learn the tools of passing ownership down to the next generation in a tax-effective manner, such as gift-tax exemptions, trusts, and life insurance. And if you inherit ownership that is held in trust (or the equivalent) rather than directly, it’s essential to understand the distinction between being a trustee and a beneficiary. These topics can feel overwhelming to master initially (when was the last time you looked at the trust documents for your family?), but it’s worth doing the work to learn what has (or hasn’t) been planned and what the consequences will be for your family. Understanding estate planning will help you make better decisions for and with the next generation.
- Family business governance: Family businesses are more complicated than non-family businesses because there are more constituencies that need to be accounted for, each of which has different objectives and plays different roles. We use what we call the “Four Room” model to differentiate the main constituencies: family, owner, board, and management. Like a house, different work is done in each room (e.g., cook in the kitchen, sleep in the bedroom). And the rooms need to be connected to each other for the house to function effectively. As an owner, you should understand how decisions are made, including which of the Four Rooms you are involved in (it could be only one or all four), as well as your decision-making rights and responsibilities in each.
- Corporate governance: The most effective owners are well versed in corporate governance, the system of rules, practices, and processes by which a firm is controlled and directed. As an owner, one of your most important responsibilities is to set and adjust these parameters via key legal documents (e.g., articles of incorporation, by-laws). Beyond the documents, and rather than make day-to-day decisions, another key responsibility is to elect the directors of the board, who will hire and provide wisdom, direction, and support to key business leaders. Having an effective board that serves as both a bridge between the owners and management, as well as providing a buffer between them, is one of the most important factors that shapes the success of multi-generational family businesses. Your family business may have an informal board, an advisory board, or a fiduciary board. You should understand these different configurations and their implications for how decisions are made in your family business. You should also be clear on what role the owners, the board, and management play in decision making – so you can leverage the board and management’s experience, but also provide adequate guidance when their interests or perspectives diverge.
- Owner Strategy: A critical role of owners is to determine what success looks like for the business. You likely care about its financial performance, but it is probably not the only objective that matters for you. To inform your perspective what success looks like for your family business, you should build the skillset to create what we call “Owner Strategy”. This is how you can define your purpose in owning the business together, identify your goals as owners, and develop financial and non-financial “guardrails” (e.g., boundaries, or proverbial “rules of the game”) that give the board and management guidance as they make decisions about the strategic direction of the business. Effective ownership isn’t always measured solely by financial performance. It can be just as important to focus on non-financial goals for the family, too.
- Corporate finance: Finance is the basic language of business. It can be a challenging language to learn, but you don’t need to be fluent. In particular, you should learn some of the key metrics and ratios that explain performance, including total shareholder return, return on equity (or investment), debt-to-earnings, and dividend payout ratio. You should also be familiar with key concepts around how businesses are bought and sold – valuations, transaction discounts, and comparables. We have found that this is best done through a mix of courses or book learning to understand the core concepts, followed by periodic reviews of your business financial statements with someone who has both the expertise and patience to help you understand them. Your goal should be to understand the data well enough to be conversant on Owner Strategy (see above), to notice anomalies, and to ask probing questions of the board and management. An important note: Don’t expect the concepts to make sense the first time around. Like learning a language, your understanding will get better with practice.
- Personal finance: In a family business, personal finances affect the health of the business. The two are much more interconnected than might first appear. Owners generally receive a share of the profits of the business through dividends, which is reasonable since they are taking the risk of investing their capital. But when shareholders become too reliant on those dividends for their lifestyles, it can result in an underinvestment in the company that will affect its long-term health. As a consequence, one of the most direct ways you can contribute to your family business is by learning how to manage your personal finances. As a shareholder, you get the “final call” on a share of the profits after all expenses have been paid and all necessary reinvestments in the business have been made. When your personal finances are in order, you can make better decisions for the business.
- Communication: A family business is a team sport. Much of your success will be determined in how you work with your fellow owners, family members, board directors, and business leaders. Effective and productive communication will be essential as you do that work. It helps build trust, which can be especially useful when difficult situations arise. Most of us are not natural when it comes to having challenging conversations with others, especially with our family members, whom we are often told to get along with no matter what. But communication is a skillset that you can learn by accessing the many tools available (such as the book Difficult Conversations).
- Negotiation: In a family business, your life is highly intertwined with your family. It goes well beyond the standard issues that all families face – like who should host the holidays – into a complicated web of topics, such as who gets different roles in the family business or how much money should be distributed to owners vs. reinvested. Learning how to effectively negotiate is a survival skill in this environment. Becoming a competent negotiator means, among other things, knowing how to differentiate between positions (e.g., Sue should be board chair) and interests (e.g., we want the most qualified board chair regardless of whether they are family or not), as well as how to build common ground. You don’t need to be win every argument, but you do need to be able to express your point of view clearly and discuss and challenge other points of view. Building these skills will give you the tools you need to navigate the never-ending issues that accompany being an owner of a family business, as well as find solutions that are to the greatest benefit to everyone.
How is it possible to develop all these competencies?
On first blush, this list of skills might initially feel overwhelming. But it doesn’t need to be. Owners require a breadth of knowledge, rather than deep expertise. They need to be conversant, not fluent.
Consider competency through the lens of a homeowner. Effective homeowners have a basic understanding of the core systems in the house, like plumbing, electricity, and heating/cooling. But what many don’t know (and often don’t need to!) is how to fix the plumbing or a broken outlet. Instead, they need to understand enough to know whether there is a problem or opportunity, whether they or their family are capable of solving it, and who to call in an emergency.
How do owners build competencies?
Building owner competencies takes time. Knowing that, it pays off in the long run to create opportunities and processes for next generation owners to begin to build these skills long before they’re needed (oftentimes over many years!). So, what is the best approach?
Almost all family owners we know start with the same two steps. First, they assess current levels of understanding for each of the competencies, both for themselves and their children. In fact, some families we know score themselves and others in their family on a 1 (“I know nothing”) to 10 (“I could teach a course on this”) scale. Second, they define minimum standards of knowledge for each competency – what it means to them to be conversant, but not fluent.
In order to fill the gaps in competencies, some families leverage internal resources to deliver programs. For example, one family enlisted a retired executive and board member to coordinate monthly sessions with their next generation owners focused on interpreting financial statements.
Other families build capabilities by doing work. For example, another family owner group undertook an Owner Strategy project to help current and next generation family members better understand the historical strategy and performance of the business as part of an effort to both learn the business and set future owner goals and guardrails. Through the process they were surprised to learn how successful the business had been during the past decade, which further strengthened relationships.
Some other families work with their trusted advisors to develop content. As an example, another family enlisted their trust and estates attorney to teach their next generation about trusts, trustees, and beneficiaries.
Beyond work, internal resources, and close relationships, business and other schools may be options for some future owners who are willing to dedicate the time. And custom educational sessions exist to help develop specific competencies, for example Kirby Rosplock and Tamarind Learning offer a beneficiary certification course, and business schools and FFI offers family governance and investment credentials, while individuals like Amy Hart Clyne at Pitcairn design custom learning and development programs.
As we saw from the unfortunate story of Sue and Paul above, not developing effective owners can be catastrophic for a business, a family, and a legacy. And while developing owner competencies is no easy task, and there is no one right path for all business families, we can’t think of a better investment of time and resources for an owner group.
A version of this article was published in Family Business Magazine, November 2023.