Playing cards too close to the vest can endanger a family business

Would a business survive if the owner were hit by a bus?

That’s an important hypothetical for a “key person” – the head of the family business, for instance. What if that person tends to play his or her cards so close to the vest that no one else could pick up the threads if they were suddenly out of the picture?

Additionally, some business founders think they’re never going to die.

“The key person will construct a narrative that will justify their hold on power and lack of transparency,” says Sach Chandaria, a board member of the Family Enterprise Foundation and fifth generation of a multi-generational global business family. It’s unlikely the person will recognize there is a problem, he suggests.

People surrounding a key person are most likely to see the warning signs that a problem is developing, says Chandaria, who is based in Geneva.

Advisors to family businesses have to be prepared to ask tough questions of prospective clients, says Neil Nisker, co-founder of Our Family Office Inc. in Toronto.

“What if you weren’t here? What’s the tax liability if both husband and wife pass away? What would happen to your 1,000 employees, or 100 employees, or 50 employees if you weren’t here to run the business? Have you shared what’s in your mind with someone else?

“A lot of entrepreneurs who are successful believe they might live forever and don’t do proper planning to guarantee the sustainability of their enterprise,” says Nisker.

A little guilt doesn’t hurt

Enzo Calamo, CEO of Vancouver-based Lugen Family Office and Medici Family Office, says it’s a matter of changing the mindset of the central figure.

“If you’re going to continue on with the business you have to have a stewardship mentality,” he says.

“With an ownership mentality you can do whatever you want. It’s your business – it’s all about you. With a stewardship mentality you’re trying to pass on the business or maintain a business for the long term. You can enjoy building the business with your skills … but you’re just the steward of the business even if you founded it.”

“I think you need a team. I don’t see a lot of that. A lot of these people don’t want to have a lot of people around them.

Enzo Calamo, Lugen Family Office and Medici Family Office

Chandaria’s advice to advisors is to root a discussion in core governance principles, which are well known and accepted. “First and foremost, there should be transparency, second there should be a proper checks and balance. And in the context of the family, depending on its size and nature and dynamics, there has to be a reasonably broad level of participation.”

A little guilt doesn’t hurt, either, he suggests. The key person should be reminded of his or her responsibility to all the people who rely on the business. “Your inability to manage the succession of responsibility will have an impact on them.”

The need for more than one advisor

Advisors also warn against a single-minded entrepreneur relying on one lone trusted advisor.

“I think you need a team,” says Calamo. “I don’t see a lot of that. A lot of these people don’t want to have a lot of people around them.”

Too small an advisory group can magnify key person risk, suggests Chandaria.

“If you see the circle of people this key person is talking to and relying on growing smaller and smaller, that is a very important sign that they are building an echo chamber around themselves to justify their ‘indispensable key person’ perception.”

Advisors also must have the wider picture, something a key person may be reluctant to reveal.

Calamo said he had a client who had asked major accounting and law firms for advice but was giving those advisors only a narrow slice of information relevant to a specific project. With a more holistic view, holes in the plan could have been spotted, he said.

“With a team it’s a bit harder to fall through the cracks. When you just share certain information with advisors and not the whole picture, they may be giving you phenomenal advice on just the point you gave them, but in the big picture of things it’s not the best advice.”

Decisions are often postponed

And having one designated hitter to step into the founder’s shoes in an emergency may not be a good strategy, either, advisors say.

“The worst thing to do is replace one key person with another key person,” says Chandaria. “If you have a key-person risk the solution should be one that involves a team of people where the responsibility and knowledge is more distributed.

“It doesn’t have to be hugely large, because that will make it unnecessarily bureaucratic, but it should not be a single individual.”

Ultimately, the key person should be the one planning for succession and recruiting the team required, says Calamo.

“They often postpone the decisions. Things that can be done along the way, such as training or introduction to potential contacts or suppliers, get postponed. … It becomes very difficult for the successor to step into the founder’s or key person’s shoes and do the job at an equivalent level,” he says.

Another protection against key person risk is documentation.

But Calamo says while it makes sense to create a best-practices manual, few entrepreneurs are likely to take that step.

Nisker says his firm can help family businesses store that crucial information. “We store our clients’ documents on a server with bank-like security and provide our families access to certain files that they can in turn provide to their children or trusted advisors.”

Shoebox files

Some clients are still relying on shoeboxes and Excel spreadsheets, he says. “I had one prospect come to me with a big black binder about six inches thick. He said, ‘If anything happens to me, everything’s in this binder.’ I said, ‘Do you share it with your wife?’ He said no.”

Another tool for mitigating risk is key person insurance, which pays out a benefit when a key person in the firm suddenly dies or is incapacitated.

“It injects capital into the business when it’s needed the most. It can be used for recruiting. It can be used for paying off loans, whatever the business thinks is appropriate for transitioning the business,” says Calamo.

Nisker adds that key person insurance is particularly important to a new organization or startup. It loses its importance once a company has an appropriate amount of equity and liquidity, he says.

An insurance payout might help matters, advisors agree, but it doesn’t get to the root of addressing key person risk.

“If the size of the business is material,” Chandaria says, “the payout won’t move the needle in terms of the solution you need to find.”

Get the latest stories from Canadian Family Offices in our weekly newsletter. Sign up here.

Please visit here to see information about our standards of journalistic excellence.