The Sure Plan for Succession Failure in the Family Owned Business

It is not unusual to meet the managing partner of a family owned business having difficulty addressing the transfer of his/her business to the next generation. But to do so is to neglect the long-term survival of their business and increase the odds for its failure. For problems of succession are indeed the greatest threats to the survival of family businesses. Market shifts, product liability lawsuits, credit crunches, supply chain disruptions, information system failures—none of these can compare to the threat of failing to plan for the transfer of family business ownership and leadership to the next generation.

Here are the disturbing facts. Today some 75% of successful family businesses fail to survive through the second generation. Far fewer survive into the third. Why? The most common reason is that the goals and objectives of the founding generation are rarely the same as those of the succeeding generation. The next generation brings with it new dynamics, including an increasing number of family members who are laying claim to the business. Failing to understand and adapt to the generational differences will bring an end to any planning process.

However, a careful planning process for ownership, leadership, and management in the business succession process will address these and many other related issues. To ignore such concerns is simply a fundamental failure to plan for success. And to do so will prove to be tremendously costly.

Comprehensive planning for succession

Effective succession planning does more than designate a family member as the next chief executive and training him or her for the job. Rather, it involves a long-term, continuous effort to balance often competing interests and pressures that are integral to a family business. These interests and pressures include not only the family members who are directly involved in running the day-to-day business, but also non-family managers and family members who do not work in the business.

A successful planning process is broad, and not narrow. To be effective, it must be both comprehensive and ongoing in order to identify the critical and conflicting issues in the family business and identify a range of options for each issue. It should also attempt to force submerged issues out into the open. These often include conflicts between parents, children, children's spouses, and other family members over family business goals and how these goals relate to personal hopes and interests. In one case, the respected owner of a large automobile dealership is still unwilling to allow his son to have full reign over the operations even though the son has been effectively leading the dealerships growth for years. The reasons are more emotional than practical. They are, however, just as real.

Experience has repeatedly shown that successful planning efforts focus on the process of planning itself rather than on any particular outcome. The establishment of an ongoing planning process encourages participants to clarify their often hazy goals to themselves and others. This clarification of goals allows for further thought, discussion, and eventual decisions that are more clearly understood by the participants. In this process, designated successors may discover an unwillingness to take over the family business while other members – who have not been seriously considered – may find a growing excitement when considering the possibility.

How best to start the planning process

Unfortunately, succession planning in family businesses often begins in response to an external event such as illness, accident, death, marriage, or divorce. Ideally, planning should not begin as a reaction to a single event. It is very unlikely that good succession planning can proceed, for example, during a major health emergency of the business leader or the period of mourning following the death of a family member. Instead, leading family members should acknowledge the integral importance of succession planning to the ongoing health of the business, the relations of family members to the business, and the relations of family members to each other. The overall task can seem overwhelming unless the succession journey is mapped out one leg at a time.

Early in the planning process the current business leader(s) should guide family members through a strategic planning process. Doing so will highlight the major issues of succession planning and help participants see that theirs is hardly unique. This realization can open the minds of many to considering solutions that have been successful for other family businesses.

As the planning process unfolds, it is important to keep all family members informed about recent decisions, current issues, and future concerns. Regular updates, such as a quarterly planning memo, can directly communicate important information to all involved. An old axiom applies here—better solutions develop from better communications.

Most families find that some members will take an active role in the business while others remain passive. The respective obligations and rewards for such member should be explicitly defined. Though the definitions may be given by the current business leader, family members should be able to weigh in with their own views. At times, a written set of “guiding principles” can help. For example, I know of several family businesses who have written something akin to a “Values Charter” defining how the family business will be run. In one Charter the commitment to rewarding those responsible for the growth of the business – whether they are family members or non-family managers – is mentioned. There, the non-family members enjoy a larger bonus than non-active family members.

Because of the conflicting values guiding a family and a business, it may be helpful to use a third party advisor to guide the family through the succession planning process. In facilitating the planning process, the advisor can help the family identify the relevant issues, including the more hidden ones, while avoiding much of the interference that emerges from normal family emotions. The independent judgment of the advisor can serve as a means to consider alternatives, resolve conflict, and overcome opposition.

Addressing the needs of family members, managers, and owners

Major issues that the family must ultimately resolve include such technical concerns as legal structures, share ownership arrangements, estate planning, inheritance tax provisions, management succession, and compensation. These should be addressed after the larger goals and vision for the family business has been set.

Once the overall direction has been set, it becomes easier to sort through the myriad of decisions that must then be made. These include: motivation and competence in the next generation, control during management transition, fair compensation to various children, potential sibling conflicts (including sibling spouses), fear of family obligations, historical lack of commitment to promises, fundamental differences in interests and personalities, etc., etc., ….

Only after family members address their major concealed issues should they move on to resolving the technical ones. These matters need to be defined in some detail in order to avoid misunderstandings and a future unraveling of settled points. For example, compensation plans should distinguish between passive and active shareholders, family and external board members, family and outside managers, family and non-family shareholders, etc. Furthermore, the compensation plan should specify principles and some details of bonus systems, stock option plans, potential "A" and "B" shares, straight salaries, etc. Other specific provisions might include methods of creating liquidity for children, the need for non-family directors, a specification of the appropriate roles for family and non-family directors, and methods for conserving capital in the business.

Major consideration should be given to establishing a family protocol to define the family's relationships to the business. These could perhaps feature a statement of five-year goals and a set of rules that might include the sort of training expected of family members who become executives. Should they have experience working outside the business? How should they circulate through different departments of a larger business? Because successful family businesses have shown that making it "easy to get out" makes it "easy to stay in," there should also be a clear set of rules on how to purchase the shares of family members who wish to cash out their stake. There should also be guidelines established for the potential sale of the business as well as for its diversification.

Finally, the rules should also include rules for changing rules, as well as for designating a third party as a "process arbitrator" to help in the case of unresolved disagreements. Just as planning for succession is an ongoing process, a family protocol or business constitution should be regarded as a living document that should periodically be revised.

As a family business leader, you start out with the odds against you in transferring a successful business into the next generation. If you make a concerted effort to plan for succession, you will reduce these daunting odds. And if you start the succession planning process early and integrate the process into a normal, ongoing part of your business, you will considerably improve your chances for achieving a successful generational transition.

The choice is yours. In practical terms, a failure to plan for succession is simply a plan for failure.

Written by Paul R. Brown, M.A. Principal of Summit Advisory LLC.

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