Fairness Is Key to Attracting, Retaining Outside Talent To Family Businesses

From the "mom and pop" corner store to Wal-Mart, the world's largest company, statistics show that family businesses generate the majority of American wealth.

According to the Institute for Family-Owned Business, nearly 40 percent of Fortune 500 companies are family controlled and family businesses account for 50 percent of the GDP; generate 60 percent of the nation's employment and 78 percent of all new job creation.

But very few businesses can boast the longevity of New Hampshire's Tuttle Farm—America's oldest farm, founded in 1635 and now run by the family's twelfth generation. Nor can they match the legacy of the remarkable A. Duda & Sons, which has grown from the 40 original acres purchased by founder Andrew Duda, and their first cash crop of celery in 1926, into expansive farming operations encompassing vegetables, citrus, sugarcane, sod, nurseries and cattle in Florida, Texas, California, and Arizona and beyond.

Rather, the average life cycle of a family business is 27 years and only 30 percent are ever run by the children of the founders.

Broad Experience

Running a successful company in today's global marketplace takes broad experience and an array of talents which even the most accomplished families cannot guarantee generation after generation. Rupert Murdoch's News Corporation is a good example.

Murdoch, 72, built the company into one of the world's largest media empires and is grooming his two sons, Lachlan and James, to take over. Although they have reportedly done well managing parts of the business, critics point out they lack broad experience and say, "Their main claim to succession is that they are the sons." For the time being, Wall Street is placated because Murdoch has tapped Peter Chernin, president of the News Corporation and Fox News (81-percent owned by the News Corporation), to be his immediate successor should anything happen to him.

A 15-year company veteran, Chernin reportedly is a master at managing Murdoch family dynamics, especially his relationship with Rupert, setting clear direction and empowering his subordinates. But his contract expires this year and he hasn't signed a new one. Ultimately, Chernin's decision to stay may depend more on his ambitions to be No. 1 in his own right at another organization, rather than simply on his compensation package from Murdoch. For now, Wall Street is holding its breath but as The New York Times reported, "...investors want to be sure Mr. Murdoch has a strong successor in place."

Nothing like Skilled Management

Just as with the News Corporation, in our experience with closely held companies, family dynamics, including values and management style, are extremely important determinants of success and outside candidates for executive positions are well advised to study them carefully. But as family business expert James Lea has observed, "Be it ever so humble, there's nothing like skilled management... Consistently capable management is essential for any business to survive and thrive. The person in charge can be coolly confident, brash and blustery, or shy and self-effacing. It's being able to work with a budget, sell value as well as price and motivate people to do their best that keeps a family business going."

Unique Talents

Outsiders who bring unique talents, experience, a compatible personal style and sensitivity to the family-driven organizational culture have an advantage when joining family companies. Especially if their value is perceived from the start, there are likely to be fewer immediate or potential competitive tensions with various family members. And the more the outsider is respected and relied upon, the more valuable—and difficult it becomes to replace them.

Having said that, anyone going into a family business needs a solid contract with a meaningful severance clause because "blood (truly) is thicker than water."

Fairness and Objectivity

Family dynamics aside, what about compensation? Insider or outsider, compensation is one of the most critical issues in attracting and retaining uniquely qualified and experienced top executives. We have seen that a compensation system that promotes fairness linked to shareholder value creation works best, and that fairness stems from applying a set of objective criteria to family members and outsiders alike.

One of our responsibilities as an executive search firm working with family companies is to help them develop compensation packages matching those for top executives in non-family run businesses, which typically include annual base salary, annual incentive compensation linked to annual performance objectives, and long-term incentive compensation linked to creation of shareholder value. To attract the best candidates, family firms either need to meet these standards or give higher base and annual incentive cash compensation to offset the absence of long-term, equity-based incentive.

Annual Base Salary

Here's how we might advise a hypothetical client - let's say for a $500 million chemical company. In this case, industry survey data would tell you that the CEO's annual compensation would be in a range of "X." to "X+" Depending on the annual and long-term components and adjusting for regional factors, it is then possible to set the salary within the industry-wide norms.

Annual Incentive Compensation

In the same vein, assuming that the exec does have a long-term compensation plan, and assuming a base salary in the middle of the industry range, we would counsel that the annual bonus target should fall within the mid-range as a percentage of annual salary. In our example, available data for the chemical industry indicate that the annual bonus target is roughly equal to the annual base salary.

Long-Term Incentive Compensation

Most importantly, of course, a company president needs to have long-term shareholder value creation as his or her primary objective, and therefore compensation must be aligned to it.  Moreover, a valued president needs to have a plan that creates the proverbial golden handcuffs that discourage him or her from even considering another opportunity dangled by a competitor or an executive recruiter(!). It is a challenge to create appropriate long-term incentive within a family's ownership structure.

For publicly traded companies, stock options have been the way such incentives have been awarded. For family organizations where options do not pertain, we have seen at least a couple of successful methods. One is to provide additional cash bonuses linked to meeting a series of annual targets (such as those that would result in a 10 to 15-percent compounded annual increase in shareholder value). The payout should be large enough to motivate the outsider executive to meet the goals.

Another approach is to establish a current estimated market value of the company (for example, using the [average of the last 3 years' EBITDA x a market multiple] minus long-term debt) and then make the same calculation in another three to five years, paying a portion of the difference. 

There are other approaches. But when determining the specific package, the key question is, "Will this incentive plan align the goals of the executive with those of the family shareholders?" 

Until next time...

Kincannon & Reed
September 2004