Practice Emphasis| Professional Affiliations | Education
Succession in Family Businesses
By Michael Dishon, Ph.D.
A father, now in his mid 70s, built a business with two of his sons. While there are two other children, they were not actively involved in the business. The father recently suffered from a couple of mild strokes and he now wishes to retire. He deems both of his sons as unsuitable for succession. The younger son is unsuitable because he's too soft and he won't be able to stand up to his brother, and the older son because he has been separated from the business due to long-standing conflict with the father, which at some point erupted into violence.
The father does not want to let the older son run the business, because he feels that he is too aggressive, made some bad business decisions, and will overpower his brother and take advantage of him. The result is that the business is now up for sale under less than optimal conditions, which include a weak market, lack of family agreement, and a threat of illness or sudden death. Unfortunately, this kind of situation is rather common, demonstrating that transition may occur in less than optimal ways.
Many of those businesses were started after World War II and many of their founders have retired or are about to retire. Succession in family businesses is a rather neglected aspect of running a family business. Only about a third of businesses manage to successfully negotiate this treacherous passage in the business' life cycle, and only about 15% of businesses make a successful transition to the third generation. This means that the hard work of starting a business and leading it to success gets squandered away, and that the accumulated wealth might be lost to the family. These statistics strongly suggest that this type of transition represents a serious stumbling block for FOBs.
While the more common transition is from parent to offspring, sometimes the transition is to a wife, widow (surviving parent), or other relative. We are not talking about those businesses that the family decides to sell, but rather those families that try to keep the business in the family.
What, then, makes this process so difficult for the majority of businesses? In many cases, this is because of lack of planning, the sudden death or illness of a member of the founding generation, and more commonly, because of the conflicts which are typical when the subject of succession is raised. Clearly, beginning succession planning after illness or death have struck is too late. Other reasons for the difficulty involve the selection of an inappropriate candidate for succession, sometimes compounded by the lack of adequate training or preparation of the successor. One often cited reason for the lack of planning is that people don't like to confront their own mortality. While that may be a contributor, I am of the opinion that a greater contributor is family dynamics.
The planning of succession requires traversing the following nontrivial steps:
1. Family discussion on how the process will be conducted.
2. Discussion about the family and business long-term goals.
3. Identification of a successor
4. Preparation of the successor
5. Transfer of power to the successor.
These steps are not listed in a chronological order. They can be accomplished in a variety of ways, but they all need to be addressed to make the transition successful. Now we will consider each of these steps in turn.
Identifying a Successor
Identifying a successor is a very important and difficult step. It is not just a matter of family politics, but also involves the question of where the business is going? This is an important question because the direction of the business will (or should) influence the choice of successor. Since the successor will be groomed for a leadership position, there should be a fit between his or her skills and the needs of the business. With a business and strategic plan in hand, the family can begin to create a profile of the necessary skills. This information can then be used as a guide in the selection process.
One question to consider is who decides on a successor. Sometimes it is the founder, sometimes it is the whole family (including those that are not active in the business) and sometimes it might be a board. Clearly, the choice of decision-making process makes a difference. For instance, consider the situation in which the founder designates the successor. The selected person will likely be seen as a favorite of the founder, and that may create familial conflict. This, then, suggests that the process should be more objective and less emotionally-laden, perhaps involving help from outsiders who would contain the conflict, guide the family through the necessary decision-making and keep the whole process psychologically as clean as possible. There are many newspaper articles which discuss families whose members are suing each other, attesting to the serious difficulties that some families run into. Some examples you may recall from recent years would be the wine-making Gallo family, the Hart family, owners of Crown Books and the Farmer family of Farmers Bros.
Preparing the Successor
When done ahead of time, there is an opportunity to train and develop the successor. The training should be tailored specifically for the designated successor, based on the successor's skills and experiences and the business needs.
One aspect of the training should be ongoing briefings to the successor about the state of the business and its finances. This ensures that the successor is up to date so that if events dictate an accelerated transition, the process will go more smoothly. Should a transition be forced by events, the unprepared successor could engage outside temporary help, such as might be offered by a board, or a cadre of experts in various fields.
The preparation of the successor might involve the time-honored method of mentoring. The ideal mentor should be about 10-15 years older than the successor, and should be from the same business field. The mentor's job would be to guide the successor, be a sounding board and be willing to share and discuss experiences. Ideally, the mentoring relationship should terminate with the agreement of both sides. While a parent can be a mentor, this approach might be more difficult.
Many successors will come from within the business. They may be groomed from early on and perhaps carry an age-appropriate role in the family business. They might grow with the business, know it intimately, and feel comfortable in it. However, before they can become successors, they will need to become their own person. If they have never worked outside the family business, it might be important to require that they take some time to work in an environment which requires the show of competence and which rewards leadership, entrepreneurial devotion, and success. The successor will need to be educated in business finances and will have to show that he or she can make sound financial business decisions. Furthermore, the successor needs to have a separate support system in place, and also be able to maintain a clear perspective on the family issues involved in the business. Their entry into the family business needs to be their own choice and not one that is foisted on them. If the founder expects the eldest son to take over, assuming the son has the interest and the capabilities, that may be fine. Bribing the son into accepting the deal by offering financial incentives will tend to backfire. The choice of a successor needs to be primarily a business decision. Unfortunately, as the statistics show, in some situations the successor is set up for failure. In my view, the minimum requirements for a successor should include:
Three to five years of outside experience
Experience in directing others
The ability to manage relationships, inspire and motivate
Ability to show initiative, and interest in the job
Handing The Reins of The Business to The Successor
Handing the reigns of the business to the successor is not only a question of timing but also a matter of process. In one business where I consulted, a daughter who had no role in the business, nor any business experience, was selected as a successor. She became president before she was actually trained for the position when her aging father needed to retire for health reasons. The father let go of his role in the business, except that he was available in a consultative capacity on an informal basis. Immediately after her installation as president, the economy took a downturn and the business which hitherto had been profitable started to lose money. Realizing her dilemma, she chose to hire a general manager who helped her back to profitability. Decidedly, this was not the best execution of a transition plan.
Orderly succession requires a clear plan, perhaps even a written contract that clearly defines the responsibilities of the successor during the transition. This will go a long way toward eliminating confusion, and it will also allow for periodic performance reviews. Getting feedback on progress will allow the successor to fine-tune their efforts and instill confidence in their ability. Of particular concern would be the person's interpersonal skills, which are so important to motivating a workforce, and his/her ability to navigate family issues. One of the most important aspects of the transition is the adequate preparation of the successor in financial matters. Unfortunately, many founders fail to train their successors in this area. They don't discuss the business' finances and don't share that information with the designated successor. I saw an example of that in a business run by a mother and three sons. The father had died a few years earlier, and the mother was thinking of turning over the business to the three children who had various roles in the business.
However, she withheld financial information, saying that the children were not equipped to understand it and its implications. This was odd because the sons had no way to judge the performance of their respective functions. However, after some discussion, the mother understood the need to prepare the sons and she began to provide financial data, allowing the sons to make more informed business decisions. Clearly, this was essential for the sons' own development and for the continued growth of the business. It also allowed the sons to begin to develop their own view of the business so that they could create a vision for what the business can become.
Sometimes a stumbling block to orderly succession is the founder's reluctance to retire and/or hand over the reins. This may put the successor in an awkward situation and lead the two into a struggle for control, with the founder trying to hang on, and the successor trying to obtain sufficient autonomy. The desire of the founder to maintain influence may have negative business consequences as it may prevent the successor from optimum preparation for the role. In many cases, this can only be resolved with outside intervention.
Simultaneously with and as a part of the succession plan, there needs to be a plan for the gradual transfer of ownership of the business. This is an area for lawyers and financial planners to help with, as it has significant financial, tax, legal, and familial implications. Often, a trust will be created. But it is essential that it take the business and family needs into account. You will find more on that immediately below.
Preparing a Will and/or Trust
This aspect of the transition plan is sometimes overlooked. At other times it is handled as if it were only a family issue with limited implications for the family business. Clearly, if substantial wealth has been accumulated and if the goal is to transfer the business to the next generation, the issue needs to be thought through carefully. Money-related issues, like inheritance, can become serious problems which sometimes end up in litigation after the death of the business founder. During the litigation, the business is often deprived of essential cash flow. Suffice it to say, that if not handled well, meaning if the will or trust creates family tensions, jealousies and conflicts, the business will likely suffer.
To make a successful business transition, it will be essential that the needs of the business be considered. That means that there should be a business and strategic plan, and that the trust/will be periodically reviewed and adjusted in order reflect the changing business and familial needs. Saying it differently, where the business is going should be an important factor in designing the will or trust. This has the advantage of turning the question of inheritance into something that all family members can participate in. It could turn the process from a fight about who is going to get the biggest slice of the pie, to one in which the survival of the business becomes the issue. The family can then engage in a discussion and decision-making process which makes family and business sense. It avoids the situation in which the founder makes his or her decisions, with the rest of the family feeling that the founder's favorite person was selected regardless of ability or interest. For some families, involving everyone in the decision-making process may be natural, while for others it may be a strain. Regardless, the consequences of various action options should be weighed to avoid later conflict.
Variations On The Theme of Succession
There are numerous ways to proceed with a succession plan, all depending on the particular family circumstances. Having a single heir may simplify things, but is not an automatic shoe in. Traditionally, even if there are several children, only the oldest son might seriously be considered. With the founder's encouragement, the child is prepared and when ready, the founder assumes an advisory role. The reality though, is often different and more complex. It is more likely that there will be several heirs, and interested offspring. Some may be involved in the business, while others may not. One way to deal with this circumstance is to teach the offspring how to handle a business as a group. They will learn enough to know how to make financial decisions and they learn to work together as a group. When the time comes, they are better equipped to handle the transition. Upon transition, they may form a new corporation comprised of siblings, cousins, children-in-law and others. They might elect officers, define roles, and learn how to resolve differences, while making business decisions.
Sometimes, there are inactive family members, or an inactive owner. Most typically, the interests of the active and nonactive members are different. Active members are more likely to be concerned with the continued viability of the business, while inactive members may mainly be interested in receiving cash. One way to deal with this is to leave the inactive members assets other than stock in the corporation. If stock is willed, it should be on the basis of some restrictions, as for example, forbidding the sale of the stock to outsiders, and having a redemption schedule which is tied to the company's performance.
Sometimes, it is the widow of the founder who is left with the business. There are scores of cases where the surviving spouse, often a wife, took over even though she did not have any business experience. While she could theoretically sell the business, or turn it over to one of the children, she may sometimes face the need to bring outside management. This could be risky for her and the business, and it requires careful consideration.
Sometimes, there is no family member who is a potential successor. This happens when there are no children, or none of the children want to enter the business. This would require the hiring of a professional, or the selling of the business. If a professional is brought in, it is important that he or she understand the family's goals and be able to operate within the family's expectations. However, this needs to be balanced with the changing needs of the business because the professional cannot be expected to succeed under conditions in which their decisions can be arbitrarily changed because the family interests diverge from the interests of the business.
It is common in family businesses that planning for succession is neglected. While understandable given all the potential complications, this is an unfortunate state of affairs. For instance, lack of succession planning has been associated with lower profit levels, greater family conflict, lower probability of a successful transfer of the business to the next generation and more. For those who find it hard to let go of the reins, the first step would need to involve helping them find new interests and sources of satisfaction. To the extent that succession planning will require more family discussion than may be common in a particular family, resistance to altering family relationships may increase rather than decrease. A smoother succession process is more likely when the parent is willing to let go and when there is at least one offspring who is competent and interested in taking over.
Clearly, there is no formula to apply in these situations. Each case has to be judged based on its own circumstances. We discussed the necessity for preparing the successor, but we need to add that the departing chief may need preparation for their parting. Although there generally is a low probability that the planned successor may die, sometimes it is prudent to have alternate plans.
What adds to the potential that a plan may work are clear leadership, lack of defensiveness, flexibility, and good communication. Those who have gone through a difficult transition will likely attest to the value of planning. But as is often the case in human affairs, each person or generation has to discover the process for themselves.
David Bork. (1986) Family Business, Risky Business. New York: AMACOM a division of the American Management Association.
Paul Rosenblatt, Leni de Mik, et al. (1985) The Family in Business. San Francisco: Jossey-Bass.