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Best Practices for Family Business

By December 26, 2006July 12th, 2023Management and Leadership4 min read

Most articles and books written about family businesses have focused on the various thorny problems and emotional entanglements that come from working with family members. Less focus has been placed on the unique business challenges that stem from the fact that most family businesses are relatively small or medium-sized and do not always have the best possible operating practices in place.

In fact, most of the operating practices a typical family business uses come from inherited wisdom, the school of hard knocks, and from textbook business principles that do not always take small business realities into account. But most of the challenges family business owners and managers face stem from the fact that ownership is highly concentrated, and usually in the hands of the people who are running the business. These leaders tend to operate in relative isolation and do not often receive independent input.

However, if family-business leaders could step back from the day-to-day of running the business and look behind the scenes, various problematic business areas would emerge that need to be addressed with a set of best practices. And those family businesses that employ best practices are often the ones that survive and thrive.

This column, the result of a meeting with several colleagues on how to better educate the owners and managers of family businesses, offers three best practices for problem areas unique to small family businesses.

1. Creating a debt management system. This important best practice relates to a family’s attitude toward debt. Most accepted principles about debt come from the people who are trying to sell money, and they may not have the business’s best interests in mind. These principles focus mostly on securitization and not as much on ability to repay. But debt is one of the few things that can kill a business and this fact needs to be acknowledged.

Bottom line: A system must be set in place to ensure debt is managed effectively.

2. Managing cash. In a small business, the manner in which cash is used is a potential lightning rod of conflict for family members. That’s because most financial reporting systems are not formatted to highlight what happens to cash in the course of operating the business. It is fairly common for family-business owners to reach the end of the year and have substantial earnings but no cash, having lost track of the cumulative effect of decisions made about cash throughout the year.

Also, some owners are not sufficiently educated on the differences between expenses, cash outlays, accruals, balance sheet changes, capital expenditures, principal payments, and other aspects of accounting (see, 10/24/06, “Coping with Family-Business Ills”).

Bottom line: Family-business leaders should place a high priority on cash management and ensure the company has a positive cash flow after all its obligations are met. They should take any larger-than-usual distributions out of the company after all the cash needs of the business and tax obligations have been satisfied. No one should ever borrow money to pay distributions to family members.

3. Long-term planning. Having a smart business plan provides great benefit to the family in terms of communicating direction and establishing expectations. It is also good for the business to align resources and provide a foundation for delegating authority and responsibility. The business plan does not have to be as elaborate as one might find in larger enterprises. It should spell out long- and short-term strategy. It should contain a multiyear financial forecast including a balance sheet, a profit-and-loss statement, a capital-expenditure plan, and a cash-flow forecast.

If possible, the financial forecast should break down the overall business into its various lines and establish a net-before-tax number for each. This will put the spotlight on aspects of the business that are doing well vs. those that are not.

Bottom line: Once developed, the plan should be communicated to everyone and reviewed monthly. It should clearly answer these questions: Where are we going? What’s expected of me? How does my contribution fit into the overall strategy?

As noted earlier, most family-business owners operate in relative isolation and employ practices that are often based upon information that may not be relevant. Adapting these operating practices into best practices will contribute significantly to a family business’s long-term business success.