Why Your Family Business Needs a Participation Agreement

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Commitment to the family and its future generations—that's what makes a family business unique and truly successful. Looking forward to business growth in conjunction with the family's growth is what differentiates a family business from an entrepreneurial one. Family business leaders take great pride and satisfaction in knowing they are leaving their children a legacy to pass on to their children. But with those rewards comes great responsibility, including the need to develop a family participation agreement.

Key Elements of an Agreement

Family participation agreements are documents written by the family members themselves to articulate the rules that govern the way the business is managed. The key elements of a participation policy state how the business should treat family employees to ensure fairness and clear communication. Some of the conditions, requirements and issues these policies address include:

• How family members enter the business;
• How they are compensated;
• What benefits they receive from working in the business;
• The reporting structure for family members; and
• How family members leave the business – exit strategies for termination and retirement.

Conditions for Entering the Family Business

Because families grow exponentially from generation to generation, family businesses need rules that govern who may join the company. A participation agreement can provide those guidelines.

Here's how a participation policy might begin a statement of the conditions for entering the business:

"We encourage family members to enter the business, provided that:

• You have a college degree,
• You have three to five years of outside work experience in an organization larger than that of the family business, and
• We have a job available. The business does not create openings when none exist simply to accommodate family members."

Pay Structure

Family businesses have been known to swing to extremes on both ends of the pay scale. Either extreme can be detrimental to the business. Some family business owners pay family members less than they are worth, assuming that they will eventually reap the financial benefits of ownership. At the other end of the spectrum, some owners overpay family members simply because they feel the business exists to serve the family's immediate needs. Neither of these extremes is ideal. Family members should receive a base salary in line with marketplace realities. (Other compensation may come in the form of stock ownership and dividends, of course.)

Reporting Structure

Would you want to report to your sibling? Most people would answer with a resounding, "Not in this lifetime." No matter how loving a family may be, close ties can get in the way of day-to-day supervision. Ideally, family members should report to non-family managers. For smaller family businesses, this can be problematic. However, as the size of your family business increases, the opportunity for some family members to report to a non-family member also increases.

Exit Strategies

Exit strategies acknowledge that family members need to feel comfortable about leaving the business without being made to feel they are leaving the family. Family members should never stay in a family business unless they are passionate about the business's goals. In the participation agreement, some family businesses include language such as, "Our family's philosophy is that the business belongs to future generations. Every member who works in our family business is responsible for developing the business for the next generation."

Implicit in this philosophy is the agreement that family members retire by a certain age or date set by consensus in a family meeting. The next generation will find it hard to prepare if they don't know when the older generation plans to leave. Setting a timeframe forces the family, business, customers and vendors to prepare for the company's continuity.

Managing a family business becomes more difficult as the number of family owners and managers increases. The potential for disagreements increases as well. Fair and clear-cut family policies, such as a participation policy, can prevent conflicts before they arise, and will you run your family business smoothly.

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Tandem Partners' family business advisors work with CEOs and other business leaders to help them achieve a balanced approach to family and business. For more information in developing a participation agreement for your family business and customized strategies for maximizing business performance through people, please contact Margaret Wilson at 443-589-1152 or via email: margaret@tandem-partners.com .

Copyright 2005 Tandem Partners

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