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Family Business Transition:  Don’t Be Late to the Party

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A key characteristic of Family Businesses – where the founder/owner may serve as CEO for 25 years or longer – is that continuity of the enterprise beyond the first generation is not certain. This is contrasted with public companies, where CEOs serve at the discretion of the board and stockholders, and where company survival is typically a function of market conditions, competition and performance.  

Two thirds of family-owned businesses fail or are sold before the second generation has a chance to take over, and only 10% remain active for the third generation to lead.  Family businesses that maintain the same leaders for decades may fail to properly evolve, leaving the company poorly positioned to cope with shifts in technology, markets and business models.

Growing a family business and managing its transition require different sets of skills and aptitudes. The strong personality and entrepreneurial spirit that often drives a successful family business may not work well when the leader seeks to retire. An owner’s ego, combined with sheltered perspectives, may give rise to an improper valuation that condemns a successful transition. 

Prioritizing the Need for a Plan

Owners who fully expect the next generation to take over often fail to develop a transition plan, resulting in many family business owners facing retirement with no successor in the wings and no serious plan to transition the business. It has been suggested that 43% of family business owners have no succession plan in place, and less than 20% of family businesses engage expert advisors on the front end of a transition. 

Unfortunately, failure to spend adequate planning time and leverage outside resources can significantly compromise the transition process and the associated economics. It can undermine the business’ goodwill with employees, customers and suppliers; disenfranchise the next generation; and weaken the company’s long-term prospects.  While family dynamics, coupled with apprehension about business succession, often delay serious transition planning, the exercise is vitally important and should reside squarely on the Leader’s ‘to-do’ list.

Investing in Transition Planning Yields ROI

Focusing on the business may bode well for near-term performance, but an investment in proper planning often yields a substantial return by increasing enterprise value, building future leaders and positioning the business for continued success.

In family succession, a key issue is the lack of preparation of the next generation, and the need for transition planning is often acknowledged too late in the process, leaving a short period to make many important decisions. The skills and competencies required to take over the business are sometimes hard to acquire easily, especially when leadership and functional development is not taken seriously. Identifying the next generation of leadership – even 5 years before a transition – can prove crucial in allowing future leaders to prepare and develop their skills before accepting a significant role. It’s therefore critical to begin transition planning well in advance, and to engage a team of outside advisors.

A family business advisor can be especially helpful in creating a succession plan, related policies and assessing potential successors. Third-party advisors can also provide unbiased feedback and an objective view when building the transition plan and shaping the company’s future.

Grooming and Choosing the Next Leaders

While the first-generation family business leader may be highly entrepreneurial, the next generations are often tasked with building platforms for continued growth and for establishing a sustainable business culture, typically characterized by more collaborative decision making. It’s critical to ensure that incoming business leaders are capable of – and committed to – doing this.

While it’s natural to welcome the next generation into the business, try to expose them to the company at an early age; have them pursue higher education and encourage them to gain outside professional experience. An owner who pulls children into the company simply because they are ‘family’ risks creating employees and managers who are either poorly trained or simply uninterested in the business. A business run by unqualified or disinterested managers is earmarked for failure. 

Ensure that potential successors are intimately familiar with the business. Educate the next generation before they take over. Make sure they have operational experience across the business before taking on any management responsibility. 

For family members already working in the business, use performance and potential assessments to identify strengths and areas for improvement well in advance of implementing the succession plan.

A leader’s age does not confer ability, and business owners who don’t appoint the most competent leaders available – whether inside or outside the family – are taking a great risk. Leverage assessments and development plans to help determine where talents can be best utilized.

Family members chosen to lead the business should have sufficient management experience, whether gained within the business or on the outside. Initiating a family business transition without a qualified successor is a recipe for failure. Keeping leadership in the family only works if they are capable. Effecting a transition with improperly groomed leadership is essentially transitioning too late.  

Family Dynamics and Stakeholders

Family businesses often suffer from poor communication within the family – especially about the intersection of business and family issues. This leads to a lack of trust, particularly when ongoing conflicts are not resolved. The inability to resolve conflict on important issues can paralyze a family and doom a generational transition to failure.

Family businesses that are multi-generational may have large numbers of passive shareholders. Budget the time to effectively engage everyone in advance of a transition. 

When the next generation does ascend to leadership, some family business owners have difficulty relinquishing control. Relatives who become major stockholders may be reluctant to exercise voting control in the face of a strong-willed (former) CEO. This can suppress management growth within the next generation, with negative implications for the business. To foster growth (and decision-making) of the new leadership, aging business owners should consider transferring management control to the next generation as early as feasible.

Transitioning and Its Impact

Family business transitions are often complex and emotionally taxing. As the senior generation confronts retirement, it’s easy to forget that transition should also serve the needs of future owners, employees, the broader family and community. The departure of leaders, whether planned or sudden, can have a significant impact on interpersonal relationships and decision-making dynamics within the family and business, and across the base of customers and suppliers. 

It’s typical in a closely held business for key customers and suppliers to build strong – and sometimes personal – relationships with the owners. It is critically important to plan the transition well in advance, and to ensure that important stakeholders are both aware and on board with the nature and timing of proposed changes.  A poorly executed transition can seriously undermine the business by not taking steps to safeguard these relationships. This has implications for future revenue and cash flow, and for the goodwill that is considered when valuing the company for sale.

When considering an orderly transition, leaders should be mindful of these interrelationships, sensitivities and professional ambitions. If business decision-making diverges from core family values, individual family members can become disenfranchised and less committed to the business. Strive to recognize and reaffirm the shared values that bind people across both the business and family. Help the family develop shared policies concerning the integration of the next generation of family leadership.

During transitions significant changes may occur, and it can be challenging for the business to perform at a high level. Employee headcount may be reduced. New employees may be added. Changes in management relationships will likely occur. The business culture may evolve. Skills training may be required. Legacy systems and processes may need to be upgraded as transitioning with outdated systems may handicap the next generation of leadership and undermine the business.

It’s difficult for managers, employees and the next generation to remain focused and motivated while there is change and uncertainty. Indeed, as we have seen, some members of the next generation, including the likely ‘heir apparent’, may not even be interested in joining the family business. Unfortunately, many owners are not sufficiently aware or emotionally prepared to accept this. 

Key Takeaways:

  • Understand the time frames and associated costs
  • Explore the tools available for business succession / transition planning
  • Engage expert advisors who can provide third party perspectives
  • Commit to undertake proper tax and estate planning 
  • Identify and prepare the next generation of business leadership
  • Establish and maintain robust communication channels so issues and contingencies are clearly vetted and well-understood 
  • Strive to involve a broad range of family members across generations 
  • Take advantage of Family Councils and other structures 
  • Contemplate ‘what if’ scenarios, understand the likely impacts and develop contingencies
  • Develop a plan to resolve major risk areas 

Don’t be late to the party when it comes to succession planning and transitioning. Start the planning process many years in advance. Time provides options, enables potential future leaders to learn and acquire key skills and provides everyone involved in the family business the opportunity to plan, prepare and discuss the future of the family-owned business.

Learn more about our Private Client Services practice and how we help owners of closely-held businesses including family-owned businesses with succession planning.

Contact us.

This article is not legal advice and should not be taken as such or relied upon as legal advice.

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