Succession may have been a fictional series, but art does imitate life. From the Fox News empire of the Murdochs to the recent media obsession around the leadership succession plans of LVMH’s Bernard Arnault, the battles over ownership in some of the largest and most well-known family businesses are very public. While the media typically focus on the question of who will fill the leadership role in global companies, an equally important issue is how ownership is structured.
Large global entities often have rigorous equity award programs and compensation committees to ensure appropriate ownership rewards for leaders who have contributed to the growth of the entity. For private family-owned enterprises, ownership is often inherited regardless of involvement in the business, and no additional awards are considered.
As an advisor to family-owned enterprises, I see the ownership structure becoming even more sensitive when the next generation is assuming leadership or considering entering the business. An important lever to adjust ownership and attract and reward family talent is to utilize “sweat equity” — the allocation of additional equity ownership beyond “blood equity” inherited through familial bonds alone.
Why?
Family business founders often believe that giving all children equal ownership in the business is fair. Unfortunately, equality isn’t necessarily equitable and may not allow for a family ownership structure that can sustain and lead the business. Equity ownership and equity awards should reflect earned authority and contribution.
The business case for this is straightforward: Sweat equity rewards contribution and aligns incentives to strengthen the ownership of the business. It mitigates the uncomfortable situation of having equal ownership among those who contribute their “sweat” and effort into the business, as well as those who are owners only through inheritance.
Sweat equity dismantles entitlement and can improve relations among family members. It can also support a broader culture of meritocracy, rewarding contribution and performance.
How?
Designing a sweat equity program to reward family members who contribute should be based on merit with the goal of concentrating ownership in the hands of family members who are contributing to the success of the enterprise. Because of the complexities of family dynamics, this may require an independent advisor or advisory board to help construct.
A sweat equity award program should be articulated and documented in the family business bylaws or shareholder agreement and ratified by all owners to confirm that they support the program. Designing a reward system that allows family members who choose to enter the business the opportunity to earn more equity offers clarity on a pathway to concentrate ownership. This also can reduce uncertainty of leadership when older generations pass.
In addition to sweat equity awards, those family members in the business should be able to purchase equity from family members interested in selling. The rules governing the transfer of shares — including permitted transferees, purchase priority and pricing — should be clear in the shareholders’ agreement.
Regardless of the technical mechanism, the important step is having honest and sometimes difficult conversations around rewarding family members’ contributions.
When?
Offering a reward based on contribution is often considered as the next generation of family members enters the business or when greater leadership is assumed.
I do not recommend waiting until succession is an imminent issue. It should be considered prior to generational transition or the retirement or passing of a family founder or leader. Having a plan that allows for concentrated family ownership based on earned reward is a valuable way to attract and retain family talent. This can also be attractive to non-family employees, who are reassured with clarity that the family will continue to maintain leadership with generational transfers.
Conclusion
Both sweat equity and blood equity are valuable in different ways. Sweat equity spurs family members to align business performance goals and allow for performance to be rewarded. Blood equity allows for continuity of family commitment and grounds the business culture in an emotional foundation that is reassuring to employees and broader stakeholders. Distinguishing the two in the ownership structure and in succession planning is an important tool for fostering business sustainability.