Planning for an Effective Family Business Succession
June 26, 2007
J. Alan "Alan" Jensen- Portland
One of the biggest challenges in estate planning is arranging for the successful transfer between family members of ownership and control of a closely-held family business. Such a transfer must address the divergent needs of the business’ founders, successors, non-family management and family. Indeed, it is such a significant challenge that only 13 percent of family businesses survive to the third generation. In addition, although 42 percent of family businesses planning to transition leadership in the next five years have not chosen a successor, simply drafting a succession plan is no guarantee of business continuity.
Instead, a successful transition plan identifies and meets the needs of both family members and non-family employees. It fosters objectivity and communication among family members. This article discusses the needs of each of these groups and strategies to achieve a family business succession plan that keeps the business and the family together.*
Preparing the Founder
Managing a family business provides its founder with a sense of purpose and dignity, fulfillment through tangible tasks, as well as personal and financial security. Transition, therefore, is a slow process. On average, founders are fully comfortable with turning over management and control of the businesses eight to10 years after first considering the idea. A founder is more likely to effectively transition leadership if the founder believes his or her needs will be met after the transition, and is more likely to provide the successor generation with more opportunities to run the business while the founder is still involved in the business.
Founders can take several steps to prepare for an effective transition. First, the founder must be confident that he or she will be financially secure after the transition. Otherwise, the founder’s dependence on the business for his or her livelihood will deter him or her from taking steps to transition control. The founder may consider transferring only a portion of the business at his or her retirement to ensure financial security. Second, the founder can communicate to his or her successor the nature and extent of barriers the founder perceives in transitioning control. This enables a successor to become a partner in overcoming these obstacles. Finally, a founder should identify his or her goals after the transition, such as taking on a different role within the company, or committing more time to an interest outside the business.
The successor generation can also increase the founder’s comfort with the transition. First, a successor should seek to have a period of employment outside the company. Founders naturally want to leave a business with a competent successor. Outside employment provides a successor with important experience (preferably within the same industry) and demonstrates to the founder that the successor has the skills to succeed. Second, a successor also must assume responsibility for his or her professional development and financial security. A successor who asks a founder for financial support raises questions about his or her ability to run a financially viable company. Finally, a successor who listens to and shows support for a founder’s concerns regarding the transition becomes a partner with the founder, not an adversary. The important question is not when the founder is going to retire, but what the successor can do to make the founder’s transition to retirement easier.
Preparing the Successor
In the period prior to the transition, the successor needs autonomy to run the business while living with the consequences of his or her decisions. Less oversight from the founder gives the successor learning experiences similar to those the founder had while starting the new business. Several strategies make it easier for the founder to give the successor this freedom.
First, the founder should consider a period of shared leadership with the successor. This strategy works especially well when the founder and successor have roles with complementary skills, such as sales and operations. Second, the founder can give the successor increasingly challenging assignments in different areas of the business. Third, the founder should ensure the successor has objective feedback through mentors inside and/or outside the company. Finally, the founder should respect the successor’s expertise which is often in areas different than the founder’s expertise.
Preparing the Business
Non-family managers want a clear strategic direction and a self-sustaining business under the successor’s leadership. To facilitate this, founders can select and develop managers with skills that complement the successor’s skills. Founders can also involve non-family management in succession planning by developing an emergency succession plan in the event of the founder’s inability to run the company due to sudden death, or a serious illness or accident. This exercise may raise succession issues the founder had not considered. Finally, the founder should communicate the goals and timelines for the transition to non-family managers.
Preparing the Family
A common succession planning pitfall is a plan focusing only on the ownership and management aspects of the transition. Because family issues ultimately affect business succession, a successful plan includes a family governance structure. A family governance structure facilitates family unity and harmony during and after the transition.
First, a family governance structure helps provide a family with a unified vision and culture so that people with differing views can work together on important business matters. All family members must agree about what it means to own a family business. It involves a passion about the business, a furthering of family values, stewardship (both of family wealth and of non-family employees) and an understanding that ownership does not equate to a right to liquidity. In short, owning a family business is more than a financial undertaking – it is a mission. All family members must agree to this mission for the business to continue to thrive.
Second, a family governance structure facilitates harmony when family members have different roles in the business. Some family members own and manage the business, some have only an equity interest, and others (e.g., spouses) have no ownership interest but are greatly impacted by business decisions. The family governance structure provides a forum to raise and resolve the conflicts that inevitably arise because of these different roles.
A family governance structure often involves a family advisory council which conducts the “business” of the family. It does this through educating the family about the family business, creating and using fair processes, and teaching family members about their different roles in the business as owners, shareholders and non-owners. Such a council can, in larger families, be made up of separate “subcommittees” that address everything from family employment policies and family education to family philanthropy as well as vacations and assemblies. This structure allows outsiders to have a significant family role in the business.
The family advisory council also has as its purpose providing input to management regarding the family’s expectations of the business regarding risk and reward, growth, liquidity and the business values that are important to the family. In turn, the council communicates and educates the family regarding the business’ expectations about family involvement.
In conclusion, succession in a family business is a process – not an event. The successful transition of a family business to the next generation begins not with a written succession plan, but with a conversation between the owners and their children regarding business succession issues. A successful plan requires time because, at its core, business succession involves family members listening and responding to the needs of each other with respect to the succession. All family members must have an appropriate level of participation, if not in the business, then in some kind of family board that allows them to have a voice that is heard by management. Family members who share in the mission and vision of the business are less likely to view the business as merely a birthright that generates cash flow and more likely to participate in helping the transition succeed.
* These and other issues were presented by Stephen McClure, a principal of the Family Business Consulting Group, Inc., at the second annual Family Business Seminar held in Portland, Oregon, that was hosted by Holland & Knight’s Private Wealth Services Group.
For more information, e-mail J. Alan Jensen at alan.jensen@hklaw.com or call toll free, 1-800-736-2301.
J. Alan Jensen would like to thank Christopher Clark, (former associate with Holland & Knight), for his role in writing this article.
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