The Usual “Betrayal” – Certain patterns in business structural interactions become apparent if one engages in the legal arena long enough. Indeed, one advantage achieved after advising business people for several decades is that one sees themes emerge and can eventually differentiate between unusual or unique events and the type of problems in business or families that are inherent in human nature. And once one sees that pattern, one can perhaps develop both advice and methodology to help avoid recurrence.
One typical pattern goes along the following lines: an owner of a business, usually the founder, has spent twenty or thirty years building it up and it operates well now, making regular or increasing income and “almost runs itself.” A little bored, or interested in bringing in younger family member(s) or younger manager(s), the owner has developed a close working relationship with reporting managers and has “trained” them into much if not all of the business.
They are now friends or close family, have been through much together. The owner takes longer and longer vacations…or perhaps has been ill for a few months…and the business managed quite well while the owner was absent. The owner is delighted and tells friends and family that he or she is no longer vital to the day to day operations of the business and can even think about showing up there only occasionally.
The owner and younger manager have often talked about bringing the manager into owning the business and perhaps have even bonused the younger manager a small piece of the business. Everyone expects that sooner or later the younger manager will take over the business. While the younger manager often complains to third parties about the antiquated methodology of the owner or shows increasing impatience with restrictions on his or her own authority or income, the essential relationship between owner and manager appears close and supportive.
Bit by bit the owner is there less often. More and more, the younger manager becomes the face seen by vendors, employees and customers and the visits of the owner to the premises become occasions disliked or even treated with hidden amusement or tolerant contempt by the manager and key employees.
Meanwhile, negotiations to sell the manager a piece of the company progress slowly, sometimes over the years, with the owner wanting to be paid for the interest sold and to keep majority control (as he or she should-see our article on Corporate Disputes-Who Has Control When Push Comes to Shove) and the manager wanting not to pay for ownership but to receive it for the “sacrifices” already made. Sometimes draft contracts are exchanged, sometimes meetings occur weekly or monthly for years, occasionally a contract is executed in which a bonus system of ownership is created but vesting very slowly over the years with no assurance that the manager will eventually control the company.
Then it happens. The manager gives notice to the shock of the owner and leaves to begin a new competing business, often taking the best employees, vendors and customers with him or her and the owner, shocked and dismayed and having little desire to re-enter full time into the business, finds him or herself in a desperate situation in which “his” or “her” business has been “stolen” by the once trusted manager.
Sometimes the owner finds to his or her fury that the new business was years in the making and had taken preliminary steps (or more than preliminary steps) even before the manager gave his or her notice. Often the owner finds that the manager has met with key employees to discuss the new venture for months or even years before implementing the plan. The owner is not only economically damaged, but devastated by a sincere feeling of betrayal.
This author has seen this happen with variations perhaps three dozen times and the anguish of the owner is well known. The typical conversation goes like this:
Owner: “How could he have done this to me? After all I did for him? He betrayed me.”
Lawyer: “Did he ever execute any agreement to protect you from this type of action? A non compete or protection of trade secrets?”
Owner: “Of course not. I trusted him. He was like my son.”
Lawyer: “You had no inkling this would happen?”
Owner: “Never. He lied and cheated and stole all that I built over the years. I want to sue him. Destroy him. Now I have to rebuild my entire business. And he’s trying to grab my customers…the people I have been serving for twenty years.”
Lawyer: “Did you tell him he would eventually own the business if he did X or Y?”
Owner: “We were discussing it. We had been negotiating it for months. Years.”
Lawyer: “By negotiating you mean you had not yet agreed?”
Owner: “Not yet…”
Lawyer: “Does not that mean that the negotiations could fail…and if they failed he could and would leave? I mean, the key part of a negotiation rather than a final agreement is that each side is free to walk away if they don’t result in a deal, right?”
Owner: “You don’t get it. This wasn’t just business. We were friends. Almost family. How could he do this to me?”
And quite often the Owner soon discovers that many of those customers, who have dealt with the manager more than the Owner for the past several years, are quite comfortable moving to the new company and had thought the Owner had actually retired.
In one case known to this writer, the Owner was so dismayed that he went into a clinical depression and tried to commit suicide. In another case, the Owner actually attacked the manager physically. Feelings run high when perceived betrayal and destruction of decades of work in building a business occur.
In most cases when we represent the Owner we sue and in many cases we have won…but only if the manager has made significant errors in how he or she handled the confidential information or trade secrets of the old business. At times, when we advise the new business, we advise them that if they are careful in how they engage in business and have not breached any written commitments, they are probably going to be successful in avoiding a judgment. But for all parties the result is a time of struggle, anger and emotionalism. The reader should read our two articles on Soliciting Employees from a Competing Business and Breach of Fiduciary Duty for some basic law on the various causes of action that may lie.
And none of it needed to have happened. As this article will describe, there are basic precautions and structures that can be created that can minimize the danger of managers “stealing” the business from absentee owners and those structures are both fair…and vitally necessary if the owner is to be secure.
People who would not leave their wallet out on their desk at home leave their business “out for the taking” in the hands of people who are working long hours while the owner is no longer working the same hours…yet are surprised when things go wrong. Or, as one client put it, “The wonder is not that he stole my business. The wonder is that after thirty years at this game, I allowed it to happen.”
Why it happens…and how to avoid it happening…are the topics of this article.
The Basic Situation: Leaving the Day to Day Grind
Humans are creatures that enjoy variety. Advertisers have long noted that placing the word, “New” on a product can be expected to increase sales automatically. A biological anthropologist noted that it was the curiosity of primates more than the thumb or large brain that accounts for many of the unique attributes of the human race.
We like change and we like new things. Thus each year new movies, new television programs, new model cars, new clothing, etc, are introduced and we buy them even though our older versions may be perfectly sound.
It is part of being human.
And once someone has spent a few decades in business, the same process invariably comes to the fore. During the initial years of struggle, when making a payroll was a critical challenge and the founder was learning the trade, there was neither time nor inclination to become bored. Indeed, mastering the business was interesting and challenging and supporting a family and carving out a name for oneself in an industry is a vibrant and fascinating enterprise for most business people.
It is only once success is achieved and the challenges, while still there, are not threatening to the survival of the business, that one can “afford” to become stale and a bit bored. It is once that success is achieved that the dangers described in this article become apparent.
It is not always obvious. Most business people are trained to recognize problems and each business, no matter how successful, always has problems. Quite often a business owner fails to realize that what were previously struggles for survival or to enter an industry have now become much more routine problems, such as personnel squabbles or dealing with an excellent competitor. This writer well remember one client complaining that he was struggling night and day to get a contract and was pleasantly surprised when this writer reminded him that ten years before he had been struggling to pay the rent, not make an extra ten percent of net profit.
Sooner or later most successful business people begin to look for new challenges. Quite often it is entering into a new market or product line or expanding the scope of services provided. At times it is efforts to buy out a competitor or ancillary business. The types of such activities are myriad and in this writer’s opinion, are the most common results of a business person moving beyond the creation stage of a new or struggling business.
The danger arises, however, when the business person seeks to find challenges outside the scope of the business. This is not to argue that outside interests are necessarily bad. Indeed, a balanced life requires interests outside of the economic life of a typical business. When a business owner, however, loses interest in his or her business or sees it as merely interfering with the “important” aspects of his or her life, the danger arises that efforts will be made to marginalize the time requirements imposed by running a business so that the business person can concentrate on more interesting aspects of his or her life. This often happens when a person thinks of retirement but can occur earlier…much earlier.
The Danger Stated:
Why a “danger?” Because unless done absolutely correctly, a business person becoming preoccupied with matters outside the business can be a prescription for disaster. The reasons are basic but often overlooked by the business person looking for greener (or at least more interesting) pastures:
1. Business Requires Continuous Supervision. All businesses all the time. The reason the business person made a good living developing and running the business is that most people do not have the skill set to create and maintain an active business. There are few areas in life more demanding and requiring more energy than engaging in business. From handling customers to hiring and firing employees, to paying taxes, to negotiating with vendors, the typical business owner engages in tasks that cover a wide variety of efforts and, above all, requires the right balance of knowing how much time and energy to devote to a particular aspect of the job each and every day. An error can be costly or even disastrous. One owner known to the writer was so preoccupied with a tax audit that he failed to handle a major customer complaint and survived the audit to see his business sales drop by thirty percent. Another owner was on the road engaged in so much selling that he failed to note that his operational costs had doubled, essentially pricing himself out of the market. Why are there so many more employees than owners of business? Because the mix of talents and drive necessary to successfully become a business person are not found that often.
To assume that an entrepreneur can hire his or her replacement is to assume that a very difficult job can readily find a replacement and therein lies the real problem: Anyone good enough to do what you do will probably start his or own business rather than work for you. Anyone not good enough to do what you do requires supervision…and probably thinks they are just as good as you and will make mistakes.
Solutions to this problem are discussed in the second article in this series, but the point made here is that once the outside goals or boredom with the business begins to preoccupy the business owner, the vital issue of finding an adequate replacement without creating a competitor within the company becomes central.
2. You Are in A Conflict of Interest with Your Employees. Face it. Perhaps the writings of the early Marx had it right. One’s role in relationships is largely determined by one’s economic activity. Economic facts of life mean that the typical employee, no matter how fond of the boss or devoted to his or her job, is in an economic conflict of interest with the boss. Why? Because the profits of the company do not necessarily go to the employee. Some go to management and owners and absent a one hundred percent profit sharing plan, a major purpose of the business…making a good profit…is a purpose primarily devoted to improving the lot of the owner more than the employee.
In this day of New Age business psycho babble, when consultants are often hired to convince employees that they and the company are “one,” this basic truth is often sugar coated…but the average employee is fully aware that most of the wealth generated by a company goes to the owners and this forms an underlying economic fact of life that most business owners must confront if they are not there day to day to protect their interests.
And this is true for even those companies with profit sharing plans since every plan seen by this writer has the greatest percentage of profits going to the owners,
Which is only fair and right, of course. The owners are the ones taking the risk and the ones who slaved to build the business. But is also means that the typical employee does NOT have the same interest in generating a profit as does the owner. The employee earns a salary, perhaps some bonus, but is interested in furthering his or her career and making more salary, not in creating an efficient and more profitable company, necessarily.
It requires hands on daily supervision and direction by the owner to make the company efficient and effective and if that is missing, the company begins to drift and may soon become incapable of generating the type of income that the owner wants. The owners who expects employees to perform in an equivalent manner whether the owner is there or not will quite soon probably learn that the employees are seldom there to protect the owner’s interest.
And if you are not there daily protecting your interest…who will do so?
3. Out of Sight is Out of Mind. It was perhaps a decade ago that a business owner left his California operations to begin a new branch in Mexico and was gone for most of two years. At first he returned monthly but during the final year he was gone all but two months of the year.
He suddenly realized that most of the business procedures had slowly but surely altered while he was gone and became enraged when, upon his return, he met universal resistance when he tried to change them back. “They forgot I built this business.”
His manager, who had, after all, essentially run the business soon resigned, furious that what she considered improvements in procedures and methods were summarily replaced by an owner who had not really been there to see the problems she confronted. Even more basic, she had enjoyed her position of almost total authority and to be relegated to following orders was no longer acceptable to her. As she ruefully commented to this writer a year or two later (after starting her own business) “I had begun to think that the business was my bailiwick. I’d get a call now and then, but it soon was my baby and I liked that. At times I’d forget he was even out there…and that was the way all of us felt. At first, it was like the teacher was out of the room. Within a few months…after we fixed the first crisis…none of us wanted the teacher to come back.”
If you leave your business operations to others to run and the resident managers are any good, they will change them to reflect their own proclivities. If you leave it in the hands of managers who are not inclined to alter procedures you have probably left it in the hands of people with neither incentive nor drive who suffer from lack of flexibility-precisely the type who would not be able to run the business on their own.
Since the scope of this article is attempts by owners to be absentee owners who wish to maintain viable companies, the problem becomes a Catch 22: the managers who are good make the business their own; the managers who are not good enough to operate in your place are a liability in that their skills are not those you need if you wish to be away from the office.
4. Only Those in Combat Are Brothers in Arms. In World War I there was a common question those who served would ask of any one that was formerly in the military. “Were you in the trenches?” If the answer was no, a gulf would exist, a slight contempt and exclusion, that was subtle but always there.
The same for those in the trenches of day to day business. Working a business is hard and stressful work, requiring constant vigilance and dedication. Things go wrong and meeting those challenges often forms team work and bonding between the employees and mangers that one achieves when overcoming problems. Inevitably, an owner who was not there…or, worse, was enjoying him or herself at the time…is seen as an outsider and treated as such, however it may be hidden. One hears it often, especially in construction. A foreman once told me he worked extra hours for his boss because, “He’s there when I am, working just as hard, working harder most of the time.”
This is a particularly American point of view. In many cultures, the owner who dirties his or her hands is considered inept or “lower class.” But in the United States, one is expected to put sweat equity into the task and the owner who does not work as hard as his or her employees is treated with distance and annoyance by most employees and managers. This, in turn, is a primary reason why when a key manager leaves starting a competing business, as discussed in detail below, so many of the key employees are inclined to move to the new business.
5. Past History is Ancient History .Usually when confronted with lack of respect or dedication by employees who see the employer taking increasing time away from the job, the owner is infuriated and points out that for years, often decades, the owner sacrificed nights and weekends, loaned money to the business, was under paid and over worked far more than the current employees or managers. The owner often has a long list of anecdotes and war stories from decades before in which such chances were taken and challenges over come. As the owner often rightly states, without that past commitment and sacrifice, the business would not even be here today.
All too often this writer has seen the owner, over dinners or lunches, reciting such stories while the new employees or managers look on, at first with interest, then with increasing boredom, as the owner discusses past triumphs and disasters. Perhaps sensing the lack of interest, the owners often decline to talk about past lessons as time goes by. Worse, the owners find themselves repeating the stories to audiences that only dutifully listen because the boss expects it.
As one manager told the writer, “I appreciate that Dave (not the owner’s real name) went through a lot to make this business survive and didn’t take a vacation for twenty years straight. Hell, he’s told me that story five dozen times. But that was then and this is now and he’s out of touch with the realities of the business now.” He went on to describe how his owner/boss was letting inappropriate history interfere with the right decisions needed in the new market environment.
When that same manager started his own company a few years later, Dave was devastated and commented that his fifteen years of sacrifice had been ignored by the “ingrates.” I made this company with my sweat and blood and they simply want to reap the benefits.”
What I told him was that he was absolutely correct and that reaction of his manager was not only to be expected but was nearly inevitable. Few people care how a business arrived at its current position and stories of desperate sacrifice to make the business grow are only of mild interest. In a deposition during a case, the defendant manager put it well: “That was then. This is now. I’m sorry he had to work that hard to make the business grow but that’s life. What matters now is how to make the business keep growing and past history may be fun to talk about over beer but doesn’t pay the bills now.”
An owner who thinks that he or she has “earned” the right to expect loyalty from existing managers and employees because of hard work from a dozen years before is usually misguided and in for a bitter disappointment.
7. Passive Rights to Income Are Hard for Active Workers to Stomach. Legally, the owner of a business has an absolute right to control the business and pay him or herself as much as he or she wants assuming the company has requisite funds. Legally, minus a contract to the contrary, the employee or minority shareholder can complain or quit but do little else. While some resentment or passive resistance may be encountered, the owner who has created the correct structure will be the one who determines what will be paid to who including to him or herself.
Yet any smart employer is well aware that resentful employees can cause problems within a company and is also fully aware that employees who work hard inevitably value their own contribution and active earning of their pay as of greater value to the company than the overall control and direction of the company. There are few employees or managers, indeed, who do not resent, at least in part, seeing the profits that they feel they earn siphoned off in large part to the benefit of owners much less active in the business.
One can argue long and hard about the “intrinsic value” of capital or the right to income on investments. One can create economic models in detail demonstrating without a doubt that of key importance to any business is the funding capital and the role of the owners who provided the initial start up and remain as guarantors on company obligations and as owners of the good will.
The simple fact is that when one is working eight hour days and taking home less than the boss who works less hours, one feels resentment more often than not and the more absentee the owner, the more likely the reaction of passive or active resentment. That, in turn, can lead to plans to become owners themselves and, at the least, mitigates against any feeling of guilt for what others might consider disloyalty or betrayal.
8. Entrepreneurs and Owners Have Higher Status and Better Chances for Income. The United States places high value on being an entrepreneur and owner of a business and this belief is inculcated into most children from their earliest years. A nation without a natural aristocracy and where success in business was often the common way to move to a higher social status, our “heroes” are as often successful business people as intellectuals or scientists. It is Bill Gates and Ted Turner who are house hold names in America, not the man who invented the Silicon chip or the television nor the winner of the last Nobel Prize in physics.
It is our respect and, at times, adulation of the American business person that accounts in large part for the power of American business in the world. Put simply, the best and the brightest wish to own their own company and become the best in their field.
How real is it? You can determine that by a simple test: how do you feel about the school teacher who earns forty thousand dollars a year to educate your most valuable asset-your child, versus how do you feel about the successful CEO of a multi million dollar company. You might like the teacher and find what he is doing admirable…but the odds are good that your awe and respect would be given to the business success. This is relatively unique to America. In much of Europe, a successful person in business will retire and seek to become landed gentry. In America, such a person would be considered part of the “idle rich,” a term alien to most nations who would think a rich person working to earn yet more a foolish waste of time.
Thus, once any employee becomes capable, he or she will want to move to the next step on the ladder and becoming an owner is a likely goal. Concurrently, the absentee owner loses some of the respect that he or she once retained since their “business days” may be seen as largely over. That combination leads to tension and can lead to the creation of a new competing company from the resources of the old company.
The Road To Intelligent Planning
So, does this mean that the owner must be there all the time to protect his or her interest? Can an owner never distance him or herself from the grind?
No, that task is possible, but it must be very carefully planned and implemented and the first step is to realize that the challenge of successfully distancing oneself from the operations of the business is probably as great a challenge as the creation of the business in the first place.
Let us emphasize this: understanding how difficult it is to become an absentee owner is the first critical step in becoming an absentee owner. This is not the easy transition that one might fantasize, the slow entry of non owners or minority owners into critical roles. While that might be your goal, to understand the dangers inherent and the need for careful preparation over many years is the single most difficult step many owners face.
One successful absentee owner once commented to the writer that he was glad the challenge had been so great. He stated that he had become bored and jaded. “Making it so it would work when I was not always there…and that the others were just as happy as when as I was there and not stabbing me in the back…well, that was a challenge that was a good one and a good last peak for me to climb.”
Our second article in this series will discuss the steps our office considers essential if becoming an absentee owner is your eventual goal.