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How to protect your family business from internal fraud

By - | May 10th 2012

Family businesses can thrive and pay handsomely over many generations if managed well, writes JOHN KARIUKI

Vickie and Tom Njaaga inherited a fleet of matatus when their father died. But rather than design a watertight framework of running the business, or, more importantly, how to share the spoils, the two brothers decided to manage it jointly. They made the crews answerable to both of them. They both also became joint signatories of the bank accounts.

After some time, each discovered that he could fool the other with the help of the matatus crews. So, they would separately stop the matatus along the way, connive with the crews and pocket part of the day’s take, with only a fraction getting into the official bank accounts. With time, they introduced their wives to this new game, and they too would order the conductors to give them money at a whim.

Needless to say, when an argument finally broke out between the two Njaaga brothers, emotions ran high. The argument degenerated into a full-scale war that sucked in their spouses and the police had to be called in. When reason prevailed, the two divided up the matatus and other properties. This heralding the fall and fall of their late father’s empire.
The Njaaga brothers confirm a tenacious observation that many family businesses appear pre-programmed to collapse after the demise of their founders. Apparently, many families fail to carry out the crucial transition stage of leadership and all “tricks and trade secrets” go to the grave with their originators.
Stake claim
Often after the death of business founders, family members who were previously left out stake their claim in the enterprises, even though they possess little or no expertise that can sustain the business.  Witness the repetitive scenario of children being recalled from colleges, locally and abroad, to manage fleets of matatus, restaurants, commercial buildings, private schools, rental houses and shambas and so on upon the death of their parents. But instead of managing the wealth, many put everything in free fall.

Investment experts say that family businesses can thrive and pay handsomely over many generations if managed well. Such an enterprise brings the family together and provides a long-term financial security for all involved. With sound ground rules, things can work out well and everybody can earn a return as the money grows over the years. In fact, some small family enterprises grow into multinational corporations like Toyota, Warner Brothers and BMW.
David Chege, an investment banker, says that the safest way of avoiding conflict in a family business is to put each member’s role and expectations in writing.

“Draw clear management lines and make rules and responsibilities clear to all family members,” he says.
In a family business, he adds, confusion reigns when reporting structures are unclear and employees are unsure of who is in charge. Chege singles out this duplicity as the most persistent cause of failure of many family businesses.

“There are many cases where key partners in such family outfits stray into each others’ dockets producing multiple accountants, CEOs and nearly all other designations. This breeds suspicion, backstabbing and fans sibling jealousies, which are all recipes for failure,” says Chege.

He says that fairness in all dealings in a family business can go a long way in forestalling problems.
“The wage scales, promotions and work schedules should apply equally to family and non-family employees,” he says.
Chege has seen many family businesses pay their close kin astronomical salaries and non-members peanuts for doing the same job. This, he warns, may breed resentment, which can also cause the firm to fall.
Ms Priscah Nyota, a Nairobi based lawyer, says that family squabbles can be prevented by registering a business and appointing competent managers.
No association

“When appointing such a manager, go for a person who has no association whatsoever with any of the family members,” says Ms Nyota.
She points out that if the management structures are clearly spelt out, such a manager need not worry about family bickering.
“Often, family businesses grow in leaps and bounds after outsourcing management,” she says.
Ms Nyota advises people in family businesses to follow the law when disputes arise without letting emotions cloud everything.

“Everybody must bear his or her cross and let the law take its course in case of any wrong doing,” she advises. She warns that when serious issues are swept under the rag, without anybody being sued, it may lead to disaster in a family business.
“Dishonest workers, whether family members or not, should be dismissed,” she says. This not only removes a drain on financial resources, but also sends a message to the rest of the work force, she adds.

She also points out that when confronted with evidence of unethical behaviour, most employees are likely to leave without a big fuss. But she insists that the fraudsterda should be asked to sign a statement releasing the business from all liability.
“This document will provide the employer with legal protection should the fired relative subsequently decide to sue for wrongful termination,” says Ms Nyota.
Ms Nyota further says that theft in a family business is a crime. It does not fall within family law and should, therefore, be dealt with accordingly.
“Covering up such thieves only makes matters worse for the family business and reduces the other key investors to co-conspirators in the theft,” says Ms Nyota.
Formal contracts
She calls on people to draw up formal business contracts that detail every aspect of the business. She also decries the “traditional” over-reliance on spouses and children as business managers. This management gap, she says, is the bane of many failed family enterprises.

“Often this old management style presumes that such spouses and children cannot steal from the business or that they will treat the investment as their own,” she says and adds. “Other non family employees may not tell you that your spouse or child is stealing from the business for fear of reprisals,” she says.
This lawyer advises the owners of family businesses to relegate troublesome individuals to the periphery, but pay them regular dividends commensurate with their investment.

“Some family members just know how to nurture grudges, dragging historical differences in all matters, and no business can prosper when the owners are divided into warring camps,” says Ms Nyota.
She adds that if this happens, non-family employees shift their allegiance to particular members of the family eroding their professionalism and productivity.

According to Ms Nyota, the key players in family businesses must develop a succession plan to avoid future problems when they retires or pass away.  “There are many awkward situations that arise in such eventualities and nobody knows what to do,” she says. Often feuds arise over who will take over as head of the business and who knows the right contacts and has the institutional knowledge to hold the business together, says Ms Nyota.
“Owners of all family businesses must ask themselves these questions and craft succession clauses in their management structures,” she says.
Looming crisis
Ms Angela Karomo, an economist, and her seven siblings had been jointly running a large family farm for several years before strain began showing.

“The returns from the animals and crops began dwindling and our individual needs could not be met,” says Karomo. But before they began pointing accusing fingers at each other, Ms Karomo moved fast.
“I looked at the books and there was nothing suspect in them,” she says. “But I was shocked to see the number of unofficial goats and sheep that we had slaughtering for our guests,” says Ms Karomo.
One of her brothers had recently lost his job and the farm records showed that he had literality been feeding his family from the farm for free. Ms Karomo called her siblings and farm manager to a meeting where they all brainstormed on ways of turning around the farm.
Though it was a tough decision, they all agreed to pay for all the goats and sheep, eggs, milk and vegetables that they would obtain from the farm in future at a subsided rate.

The sibling resolved to put emotions and a sense of entitlement aside and employed their sacked brother at the farm and pay him a salary based on the market ratesThis way, they resolved that their farm would remain as an alternative employer for any of them who may find himself or herself out of a job.

“From our meeting, it also emerged that the manager did not have a free hand in running the farm and we immediately mandated him to work professionally without any recourse to any of us,” she says.
And with this mandate, the farm manager introduced new and profitable concepts of agribusiness like horticulture and ostrich farming, says Ms Karomo. The farm made a turnaround and began posting profits within a year.

Ms Karomo advises owners of family businesses to call for outside help when they run out of new ideas.  “People should open up the decision-making processes in family businesses in they want their enterprises to outlive them,” she advises.

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