How profits leak in family businesses

 

 

‘‘Forget “blood is thicker than water.” That kind of mentality will send you straight into a financial hole you may never climb out of. Believing that your relatives feel they have as much at stake in the business as you, is a fallacy”

George Cloutier, Author, Profits Aren’t Everything

What are the dangers for profitability with family businesses?

Company profits can be likened to a bucket of water. As a manager or owner, you are responsible for keeping as much water (i.e. profits) in the bucket as possible and plugging the holes where profits are leaking out of the business. Plugging the ‘profit leakage’ is more difficult to eradicate if the business has poor systems of management and governance.

As a former business co-owner, with 3 other partners that employed over 100 people, I was clear about the potential issues with employing family members. Having worked for several family businesses beforehand, you need very clear rules if you decide to employ family members. I had witnessed the corrosive effect on profits of ‘profit leakage’ when family members held significant positions in a business. From the managing director’s brother who was totally incompetent, to a wife who held a significant position and had low people skills which all lead to lower profits.

Here are 5 circumstances where profits leak from family businesses:

  1. Family members have different rules to other employees. I have seen situations where rules are bent or even ignored for family members. Having more than one standard can adversely impact profitability. However, this is rarely acknowledged, particularly the impact these have on employee morale as it effects motivation and productivity. For example, family member who are employed in the business may decide they have different time keeping rules to other employees.
  2. Family members having a sense of entitlement. We constantly hear stories of relatives employed in family businesses having neither the skills, training nor temperament for their roles. It is essential to have clear roles and responsibilities, and everybody including family members must be held accountable for performance, otherwise profits leak through poor sub-optimal performance. Having worked in a business where the owner employed his son, I witnessed the corrosive effect that the son’s poor work ethic and his sense of entitlement had on the business through poor morale and lack of respect for both the owner and the son.
  3. Maintaining the Status Quo. As family members age they often become resistant to change, stifling innovation and new ideas. Furthermore, they can become complacent and often have other agendas. The one certainty about business is change and anything that impedes change will lead to opportunities being missed and profits adversely effected. Business founders and leaders who stay too long in the business, often stifle change where egos rather than sound judgement, can be the basis of their decisions.
  4. High employee turnover, particularly high performing staff. There is no better indication of poor business health than top performing staff leaving. In family businesses, when high performing non-family members are passed over for promotion they leave when they see positions reserved for relatives. There are hidden costs in employee turnover. Profits leak as time and money is spent on recruiting, training, and settling in employees into their new positions whilst non-performing relatives remain in their positions continuing to negatively affect morale. I left a senior managerial position many years ago when I was twice passed over for a promotion, when the position was given to the brother of the managing director who was incompetent and lazy and generated little respect from staff.
  5. Family tensions. Tensions arise in most families and even if they do not have anything to do with the work environment they have a habit of affecting the work situation. This can negatively affect morale and the efficient and effective operation of the business and ‘leak profits’. For example, I have witnessed situations where spouses who worked together were having domestic troubles. This severely impacted the running of the business.

What is the solution?

First of all, recognise that it could be a problem. Put your egos aside and recognise the problems and deal with the issues in a rational and organised way.

Secondly, ensure that there are good systems of management and governance. Clear rules on performance, accountability and behavior are essential.

Finally, make sure that you implement and enforce these rules and management systems are followed. Outside advice using a mentor or advisor, their guidance and assistance can be useful tools to improve company performance.

Family businesses have significant advantages over large bureaucratic organisations, so don’t allow the weaknesses to over-ride the strengths as family businesses can be more nimble, effective and profitable.

So, will you prevent ‘profit leakage’ in your family business?

2 thoughts on “How profits leak in family businesses

  1. Excellent post David. I’ve found when acting as an adviser for family businesses that the process of addressing governance and rules (how decisions are made; roles for and payments to family members; succession/exit etc) draws out the issues without there being a crisis, which never brings out the best in people. Incidentally, the same might be said about our personal lives, too – we need to talk about end-of-life care, for example, and make sure our families know our wishes, rather than leaving them to try and deduce them in the worst possible circumstances, should they unfortunately occur.

  2. Hi steve. Thanks for thr feedback. Having the honest conversations are important both in family businesses and life in general as you have pointed out. Egos and emotions need to be under control.

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