Moving On Up: Transfer of Power in Family Business

Transferring power is one of the most challenging aspects of a family business. It’s often a subject no one wants to talk about, but everyone has to face. In Part I of this piece originally appearing in the Harvard Business Review, Louis B. Barnes and Simon A. Hershon discuss the challenges of transferring power to the second generation when the first generation is still around.

One of the most agonizing experiences that any business faces is the moving from one generation of top management to the next. The problem is often most acute in family businesses, where the original entrepreneur hangs on as he watches others try to help manage or take over his business, while at the same time, his heirs feel overshadowed and frustrated. Paralleling the stages of family power are stages of company growth or of stagnation, and the smoothness with which one kind of transition is made often has a direct effect on the success of the other.

Sons or subordinates of first generation entrepreneurs tell of patient and impatient waiting in the wings for their time to take over the running of the company. When the time comes, it usually comes because the “old man” has died or is too ill to actively take part in management, even though still holding tightly to the reins of the family business. Often this means years of tension and conflict as older and younger generations pretend to coexist in top management.

As one second generation manager put it, speaking of these problems: “Fortunately, my father died one year after I joined the firm.” Concerning another company, a prospective buyer said: “The old man is running the company downhill so fast that we’ll pick it up for nothing before the kids can build it back up.”

The transition problem affects both family and nonfamily members. Brokers and bankers, professional managers, employees, competitors, outside directors, wives, friends, and potential stock investors all have more than passing interest as a company moves from one generation to the next. Some of these transitions seem orderly. Most, however, do not. Management becomes racked with strife and indecision. Sons, heirs, key employees, and directors resign in protest. Families are torn with conflict. The president-father is deposed. Buyers who want to merge with or acquire the business change their minds. And often the company dies or becomes stagnant.

The frequency of such accounts and the pain reflected in describing the transfer of power from one generation to the next led us to begin a more formal research inquiry into what happens as a family business, or more accurately, a family and its business grow and develop over generations. Specifically, what happens in the family and company between those periods when one generation or another is clearly in control but both are “around”? In addition, how do some managements go through or hurdle the family transition without impeding company growth? And can or must family and company transitions be kept separate?

The research project on these questions began in June 1974 and is still continuing. It has included interviews with over 200 men and women and multiple interviews in over 35 companies, not all of which went beyond the first crucial transition test. This article contains some of the initial findings and conclusions.

Professional or Family Management?

Some observers and commentators on family business believe that the sooner the family management is replaced by professional management in growing companies, the better. The problems just described can lead to disruption or destruction of either the family or the business, sometimes both, in the long run. Furthermore, the argument goes, an objective, professional management will focus on what is good for the business and its growth without getting lost in the emotions and confusions of family politics.

This rational argument for professional management in growing companies has many strong advocates. It has even been suggested that the family members should form a trust, taking all the relatives out of business operations, thus enabling them to act in concert as a family.

Like any argument for objectivity, the plea for professionalism has logic on its side. It makes good business sense, and in a way, good family sense as well. It guides a business away from mixing personal lives with business practices, and it helps to avoid the evils of nepotism and weak family successors who appear so often to cause transition crises.

Historically, the main problem with this rational argument is that most companies lean more heavily on family and personal psychology than they do on such business logic. The evidence is overwhelming. There are more than one million businesses in the United States. Of these, about 980,000 are family dominated, including many of the largest. Yet most of us have the opposite impression. We tend to believe that, after a generation or so, family businesses fade into widely held public companies managed by outside managers with professional backgrounds. The myth comes partly from a landmark study of big business by Adolph Perle and Gardner Means, who maintained that ownership of major U.S. companies was becoming widely diffused and that operating control was passing into the hands of professional managers who owned only a small fraction of their corporation’s stock. This widely publicized “fact” was further used by John Kenneth Galbraith to build a concept which he called the “technostructure” of industry, based in large part on the alleged separation of corporate ownership from management control.

There is evidence to the contrary, though. A study reported in Fortune by Robert Sheehan examined the 500 largest corporations on this question. Sheehan reported that family ownership and control in the largest companies was still significant and that in about 150 companies controlling ownership rested in the hands of an individual or of the members of a single family. Significantly, these owners were not just the remnants of the nineteenth century dynasties that once ruled American business. Many of them were relatively fresh faces.

The myth is even more severely challenged in a study of 450 large companies done by Philip Burch and published in 1972. By his calculations, over 42% of the largest publicly held corporations are controlled by one person or a family, and another 17% are placed in the “possible family control” category. Then there is one other major category of large “privately” owned companies—companies with fewer than 500 shareholders, which are not required to disclose their financial figures. Some well-known corporate names are included in this category: Cargill, Bechtel Corporation, Hearst Corporation, Hallmark Cards, and Hughes Aircraft, among others. Burch notes that contrary to what one might expect, the rather pervasive family control exercised is, for the most part, very direct and enduring. It is exercised through significant stock ownership and outside representation on the board of directors, and also, in many cases, through a considerable amount of actual family management.4

When one thinks more closely about families in big as well as small businesses, some well-known succession examples also come to mind, suggesting that family transition and corporate growth occur together even though there may be strain in the process. For example:

  1. J. Heinz was founded by Henry J. Heinz to bottle and sell horseradish, and today H. J. Heinz II, a grandson, heads the billion-dollar concern.
  2. Triangle Publications owns the Morning Telegraph, TV Guide, and Seventeen. It was founded by Moses Annenberg. He was succeeded by his son, Walter, and a daughter, Enid, is now editor-in-chief of Seventeen.
  3. The Bechtel Corporation was begun by Warren A. Bechtel, for building railroads. His son, Steve Sr., directed the firm into construction of pipelines and nuclear power plants. Today, Steve Jr. heads the $2 billion company, which is now further diversified.
  4. Kaiser Industries, built by Henry J. Kaiser, includes Kaiser Steel, Kaiser Aluminum and Chemical, Kaiser Cement and Gypsum, Kaiser Broadcasting, Kaiser Engineering, and Kaiser Resources. The present industrial giant is headed by Henry’s son, Edgar, now over 65 years old. An obvious successor is Edgar Jr., president of Kaiser Resources Ltd.

Should a family business stay in the family? The question now seems almost academic. It is apparent that families do stay in their businesses, and the businesses stay in the family. Thus there is something more deeply rooted in transfers of power than impersonal business interests. The human tradition of passing on heritage, possessions, and name from one generation to the next leads both parents and children to seek continuity in the family business. In this light, the question whether a business should stay in the family seems less important, we suspect, than learning more about how these businesses and their family owners make the transition from one generation to the next.

Inside and Outside Perspectives

What are the implications when the transition from one generation to the next includes both business and family change, and what are the consequences also if business and family, though separate, remain tied together in plans, arguments, and emotions? In considering these questions, it might help to examine two perspectives in addition to age difference. One is the family, the other is the business, point of view. Both of these can be viewed from either the inside or the outside.

Exhibit I shows these four different vantage points from which to observe family and business members. One viewpoint is that of the “family managers” (inside the family and inside the business) as seen by both old and young generations. When they forget or ignore the other three perspectives, they can easily get boxed into their own concerns. This kind of compulsion includes hanging onto power for the older generation and getting hold of it for the younger. To both generations, it implies the selection, inclusion, and perpetuation of family managers.

A second perspective comes from “the employees,” again older and younger, who work inside the business but who are outside the family. Understandably, they face different pressures and concerns from those of the family managers, even though many are treated as part of the larger corporate family. The older employees want rewards for loyalty, sharing of equity, and security, and they want to please the boss. Younger employees generally want professionalism, opportunities for growth, equity, and reasons for staying. Both age groups worry about bridging the family transition.

A third perspective comes from “the relatives,” those family members who are not in the active management of the business. The older relatives worry about income, family conflicts, dividend policies, and a place in the business for their own children. The younger, often disillusioned brothers and cousins feel varying degrees of pressure to join the business. Both generations may be interested, interfering, involved, and sometimes helpful, as we shall see later on.

Finally, the fourth perspective comes from “the outsiders.” These are persons who are competitors, R & D interests, creditors, customers, government regulators, vendors, consultants, and others who are connected to the business and its practices from the outside. They have various private interests in the company which range from constructive to destructive in intention and effect.

A curious irony is that the more “outside” the family the perspective is, as shown in Exhibit I, the more legitimate it seems as a “real” management problem. Yet the concerns in the left column boxes are typically just as important as, and more time consuming than, the outside-the-family problems on the right. These inside-the-family problems tend to be ignored in management books, consultant’s reports, and business school courses. Ignoring these realities can be disastrous for both the family and the company.

Our studies show that the transfer of power from first to second generation rarely takes place while the founder is alive and on the scene. What occurs instead during this time is a transition period of great difficulty for both older and younger generations. For the founder, giving up the company is like signing his own death warrant. For the son or successor, the strain may be comparable. As one of these said:

“I drew up the acquisition papers to buy my father out, because for a long time he has been saying he did not care about the business anymore. However, when it was all taken care of, and we presented him with the papers, he started to renege. Everything was done the way he would like it. Yet he would not sign. He finally told me he did not think he could do it. He felt it awfully hard to actually lose the company. He said he felt he still had something to give.”

And another commented: “I can’t change things as fast as I would like to. It is absolutely clear to me that things need to be changed. However, it is not easy. First of all there is the function of age and experience as well as being the boss’s son. Every other officer in the company is in his fifties. What I am talking about now are deep sources of dissatisfaction. I would like more ownership. Now I have only 7%, my father has 80%, and my family another 13%. In my position, I just cannot move the company fast enough. We argue a lot, but nothing seems to change. I have set a goal for myself. If I cannot run the company within two years, I am leaving. I’ll do something else.”

The Company Transition

While family managers feel the multiple strains as the generations overlap during periods of transition, another related process is occurring as the company grows and develops. Various authors have tried to describe this process.5 But, where one describes a smooth procedural development, another sees a series of difficult crises. For some, a series of growth stages is important. For others, it is the merging of functions with processes that count. Most writers do not tie business growth or decline to family transitions. However, the following points stand out for us in relation to company transitions.

  1. Organizational growth tends to be nonlinear. Organizations grow in discrete stages, with varying growth rates in each stage.
  2. Periods of profound organizational development often occur between periods of growth. These slower periods often are viewed with alarm, but they force managers to examine what the company has grown toward or into. These periods of development are the transition periods which appear less dramatic (i.e., there is less growth) but may be most crucial to a company’s preparations for its own future.6 The apparent floundering can provoke useful learning once management begins to adopt and encourage new practices and procedures.
  3. A typical management response to transitional strains is a total or partial reorganization of the company. This sometimes helps shake up old habits but rarely resolves a transition crisis. What is needed is time for the social and political systems of the company to realign themselves into new norms and relationships.

Exhibit II shows how a later growth stage differs from and builds on the earlier ones. The first stage is characteristic of an entrepreneurial company with direct management. The second is typified by a rapidly growing product line and market situation with second-level management set up in specialized functions. The third stage has divisional operations with a diverse line of products and markets. Whereas the management style of the first stage is highly personal and direct, the second tends to become the more collaborative style of a boss and specialized peers. The third stage typically involves a looser, impersonal, collective style, with the chief executive managing generalists as well as functional specialists. Under the patterns of the first stage, the core problem for a small company is survival. The patterns of the roughly defined second stage show a size and scope requiring such specialized functions as finance, production, marketing, and engineering.

As the company’s size continues to increase, it is likely to evolve toward third-stage patterns of growth: At this point, different product lines become separate companies or divisions, while, in multinational firms, the separation may also be on an area basis (e.g., Europe, North America, Latin America, Middle East, Far East) as well.

In between the box-like stages of growth shown in Exhibit II appear the transition phases which help to prepare an organization for its next stage. To cross the broken lines separating one growth stage from another in Exhibit II requires time, new interaction patterns, and an awkward period of overlap. In effect, the broken vertical lines of Exhibit II represent widened time zones of varying and irregular width.

As we have seen, family transitions and company transitions can occur separately and at different times. However, we found that they usually occur together. As a company moves from the problem of survival to one of managing rapid growth, it must develop new control, motivation, and reward systems. It also requires a management style that can integrate specialists and their functions. This development cannot occur without a top management that wants to take the extra step beyond survival thinking. That is where an eager younger generation comes in. He, she, or they are more likely to want to go beyond traditional practices. This pent-up energy seemed to be a major factor in getting beyond company transitions in 27 out of 32 businesses we studied where the company had gone beyond the first growth stage.

In Part 2 of this series, the author examines the transition that occurs between the second and third growth stages of a family business.

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