Businesses that last share common traits. For example, they have written ownership agreements with key terms; they are structured to prevent conflicts and disputes between co-owners; and they have planned for timely succession to manage next generation expectations and prevent frustration. Absence of these key fundamentals will likely cause lack of alignment between owners preventing financially sound companies from lasting.
The focus of this article is on family businesses and the squabbles that frequently lead to business break ups. By their nature, family businesses are inherently susceptible to business breakups. It is easy to hold non-family members at arm’s length and treat them solely as business partners. But when they gave birth to you, you live with them, you spend Thanksgiving dinners with them, or you are the Godparents of each other’s children, the dynamics of the business relationship change. There is no longer the comfort that comes with a non-family business in which the participants can just walk away and cut all ties without consequence beyond the four walls of the brick and mortar business.
Typical family business disputes arise between parents who founded the business and their children; between siblings who are wrestling for control of their parents’ company; between in-laws who have married into the family business and the founding parents’ children; and between spouses who have started businesses together, and are in the throes of a marital divorce.
Family business disputes are typically characterized by lying, deception, back stabbing, self-dealing, attempted coups, theft, extra-marital affairs and jealousy. These, however, are the symptoms and not the cause. The true culprit is often lack of an agreement, or one that is either unclear on fundamental and key issues, or does not address them at all, leaving the family members to their own means to get what they want.
Shakespeare’s Macbeth is a tragedy about a “family business” that failed to last. An ambitious Scottish General, Macbeth, who learns that he will one day become King of Scotland through the prophecy of a threesome of witches. Drunk with ambition, impatient in his conquest for power and blind to the consequences of his actions, Macbeth kills King Duncan, frames his guards for the murder, and assumes the throne. Plagued by guilt and paranoia, Macbeth becomes a tyrant and commits more murders to protect his coveted monarchy. His wife, Lady Macbeth, commits suicide due to her guilt in goading Macbeth to murder King Duncan and many others. The play climaxes when Macbeth’s actions trigger war, and he is ultimately beheaded by his rival Macduff whose family Macbeth murdered in his effort to maintain the crown.
Similar Shakespeare tragedies often play out in the business world, particularly when an impatient junior owner clashes with a stubborn head of the business who refuses to retire. Typically these scenarios arise in the context of father/son family business relationships, but there are a host of other family and non-family combinations. The crux of the dispute is the fire that is ignited when stubbornness and impatience create friction. When you see this cauldron bubbling over, start tapping out S.O.S. in Morse Code on your telegraph to warn your best client that the clay tile roof on their tony Spanish villa is in imminent danger of crashing down on them.
The following Macbeth-like real life case study illustrates why a business head’s refusal to retire is a crimson red flag that your business will fail to last. Although the case study involves a family business, the lessons learned are equally applicable to preventing disputes between unrelated business owners.
The Case Study
Ivan was a Russian immigrant whose parents immigrated to the United States in the 1920s. Uneducated but bright, by the late 1940s Ivan had started a small specialty food store, Pirozhki’s. Soon thereafter, he married Ekaterina and they had several children, including their first born son, Vlad. In the next several decades, Ivan, with Ekaterina working by his side, grew the business from a local shop to a sizeable regional food distributor and manufacturer. This ultimately blossomed into a brand whose products could be found in supermarkets across the country.
Ivan served as the President, CEO and Chairman of Pirozhki’s. Ekaterina was the Corporate Secretary and a Board Member, and was actively involved in running the day to day business of the company, including overseeing accounting, warehousing, shipping and receiving. She had a contract with the company guaranteeing her lifetime employment. When Vlad came of age and received a college degree, he joined the family business. He started on the bottom rung by doing manual labor in their local store and, rising through the ranks, Vlad ultimately became Pirozhki’s Vice President and Member of the Board.
In his mid-seventies, Ivan showed no signs of stopping. He loved his business and the thought of retiring never crossed his mind. Ivan was in good mental and physical health and planned to work until he was unable. Vlad, on the other hand, was ambitious. Pushing fifty, he was growing impatient to succeed his father and take over the reins of Pirozhki’s. Vlad and his father had arguments about the subject on numerous occasions, and their intensity continued to ratchet upwards.
Channeling Macbeth, Vlad hatched a diabolical plan. He persuaded his mother that the Company was doomed to fail and would never make it in the modern world because Ivan was stuck in his old ways and resisted infusing new technologies to maintain competitiveness in their market. Unless they interceded and modernized Pirozhki’s operations, Vlad cajoled his mother, the company would not be viable to transfer to the next generation. Equally troubling, Vlad whispered in Ekaterina’s ear, her own financial security might be compromised. Sufficiently convinced that it was Ivan’s time to step down, Ekaterina agreed to support her son in his bid to take over the company, provoking a maelstrom from which Pirozhki’s and the family would never recover.
In a flurry of litigations, Vlad attempted to have a receiver appointed to manage the assets and business affairs of Pirozhki’s. Relenting to his son’s ambitions and in an attempt to salvage the company and family, Ivan resigned as Chairman, CEO and President, and cut all ties with the company. Except he did, however, retain ownership of the local specialty food store that had started it all. After the dust settled, Vlad was the majority owner of Pirozhki’s, and controlled a majority of the voting stock.
But, similar to Macbeth, Vlad’s thirst for power and control did not end there. After stringing Ekaterina along to back him up to take over Pirozhki’s, she accused him of forcing her out of the company and terminating her employment. Specifically, in another lawsuit, Ekaterina alleged that Vlad improperly transferred restricted shares of stock to his wife without her approval as required by the shareholder’s agreement. Vlad did this, she alleged, so he could appoint his wife as a Director and thereby control the Board. In addition, she claimed that Vlad told her that there was a generational gap between them and that although she could maintain her office, she was not permitted to supervise any employees. She also alleged that Vlad started deducting from her paycheck items previously paid by the company like her car lease, cell phone, and auto insurance, and prohibited her from contributing to her 401(k) because Vlad did not want the business to have to make matching contributions. To top it all off, she accused Vlad of cutting off her access to the company’s books and records and failing to file certain tax returns for the business. Vlad did this, as well as terminate her employment, she alleged, to mask Pirozhki’s severe financial decline that would later doom the business.
Ekaterina also alleged that Vlad mounted a campaign to poison the company’s relationship with long standing vendors who had expressed loyalty to Ivan. Vlad did this, she claimed, by racking up sizeable debts to the vendors and refusing to pay them. Ekaterina also accused Vlad of hiring his friend as CFO and excessively and clandestinely compensating him by paying him a salary plus a secret monthly retainer to his consulting company. Further, she alleged that in an effort to hurt his father, Vlad purposely refused to honor purchase orders made by Ivan to supply the local specialty food store that Ivan owned so that he was forced to purchase the goods from wholesale distributors at a higher price. Ekaterina also accused Vlad of eating at the trough by using company funds to finance lavish vacations, personal insurance and landscaping for his home.
Pirozhki’s did not survive all of the Ali-Frazier-like fights. Drained from the defense and prosecution of multiple family member lawsuits, which the company funded, the business was forced to file bankruptcy, chopped up into pieces and auctioned off like casting lots for Jesus’ garments after the crucifixion. Another casualty was the marriage of Ivan and Ekaterina. Embittered at his wife’s betrayal, Ekaterina’s alignment and partnering with their son in his bid to force Ivan out was the death knell for their relationship. The marital and business divorce took the ultimate toll on Ivan. A few years after the litigation commenced, Ivan died a broken-hearted man who had lost the company he built from scratch, his marriage of fifty years, and the loyalty of his first born son. Another casualty of the infighting was Vlad’s relationship with his mother, as they became estranged. Finally, the bitter infighting caused Vlad’s siblings to take sides, and resulted in poisoned relationships between them.
The lessons learned from Pirozhki’s are hard ones but are hopefully instructive and help you to prevent your best clients (and, by extension, you) from suffering a similar fate. What could have been done to prevent the infighting between Ivan and Vlad that led to the downfall of the company? The problem could have most likely been avoided if their shareholder agreement addressed succession by providing a date certain whereby Ivan would turn the company over to Vlad. To soften the blow to Ivan, while still satisfying Vlad’s desire to run the company, this could have been done incrementally. For example, they could have agreed to the following schedule: at age 65, Ivan would appoint Vlad President; at age 70 he would appoint Vlad CEO; and at age 75, he would appoint Vlad Chairman of the Board, and Ivan would maintain a seat on the Board for as long as he wished. This balancing act would have allowed Ivan to remain actively involved in the business and, as he reached his very senior years, be less involved on the tactical side of the business (operations) and focus his seasoned business wisdom on strategic planning to ensure transition to the next generation.
About the Author
Rocco Luisi, Esq. is a Speaker, #1 Bestselling Author and Law Firm Partner. After working in the trenches with business owners to prevent, mediate and litigate internal business disputes for more than two decades, Rocco has seen first-hand why financially sound companies nevertheless fail. Out of these deep experiences, Rocco has learned what it takes to make businesses last. Rocco speaks nationally about this important topic and his unique law practice is focused on helping his clients achieve business longevity. For more information visit www.businessdivorcebook.com.