Succession in a Family-Owned Business: It’s Not Just a Financial Issue
When the next generation takes over a family business, the decision-making process becomes far more important than the decisions that are made. Due to embedded family dynamics and emotions, the core issue of succession in a family business is almost never what the decision is but rather the acceptance of who will have the authority to make those decisions.
A typical concern, which prevents founders of family business to enjoy a good night sleep, is “How do I keep the next generation from fighting over the business?” As mentioned in some of our previous newsletters, the transition of business to the next generation is a complex matter and is the most fundamental concern of an aging founder of the business. As we mentioned in the newsletter of June 2015, only 30% of family-owned businesses make it to the second generation, only 12% passes it on to the third, and very few (3% or less) last until the fourth generation.
We all know or have heard stories of ruined family relationships and lost fortunes because a group of beneficiaries could not get along. Very often the issues that generate conflict over the family business are emotionally driven. When heirs of a family business feel they are treated unfairly or are not respected, tensions will mount and frequently explode into conflict. It is important to remember that the judgment of “fairness” is driven more by the decision-making process than by the decision itself.
The dynamics of the decision making process must change when the family business is transferred to the next generation. There is a natural acceptance of decisions made unilaterally by the founding generation. But when the elder members of the family are no longer able to make such decisions, previously compliant next-generation family members may explode in conflict over even minor decisions if they feel they have no real voice at the table. When one sibling or owner attempts to make unilateral decisions about the future of the company—the way the founder might have done—resentment among the other siblings and other owners will result, regardless of nature of the decision itself.
Even with the best of intentions at heart for the family members and the business, the attempts by the first generation owners to avoid future family conflicts can turn out to be unsuccessful. For example, some owners will sell a business with a great future so that the proceeds can be divided up among heirs equally. While this solution is reasonable because each heir can get an equal share of funds, it may be shortsighted. This immediate access to cash may be attractive to some but selling the family business deprives the next generation of the pride of sharing in the vision and mission of the founder and prematurely ends a great family legacy and an economic engine that could continue to generate wealth for future generations.
In another scenario, one family member buying out the other members to obtain sole ownership could lead to conflict. While this approach is appealing on one level—a “cream rises to the top” approach of letting the one family member in the second generation who is most involved and attached to the business buy out his or her siblings or other owners, it may also come with serious risks. First, buying out other owners can put severe financial strain on the business if it had to be leveraged or use up available liquid assets, which could cause the company under it new sole proprietorship to underperform or ultimately fail. Alternatively, if the company does succeed and continues to grow, the family members or other owners who sold at the time of transition (typically at a minority shareholder discount) will feel cheated because their shares would be worth much more had they kept them.
Another common approach is to give one or more heirs working in the business control while making those heirs who do not work in the business beneficiaries of dividends or other distributions. This effectively puts different family members into roles of “makers” and “takers.” Such an approach often opens the next and subsequent generations to bitter disputes over the salaries and benefits of those who run the business, as the “makers” often feel they deserve a larger share than the “takers” and the “takers” disagree.
One possible solution to these problem could be the establishment of a Governance Structure, whereby although the ultimate decision-making authority is concentrated in one or a few hands, all involved stakeholders would feel they have a voice (even if they do not have a vote) in the process. As good governance progresses, depending on the circumstances, the board might consider moving into a supervisory position and appoint outside independent directors who are accepted and trusted by all stakeholders for their business knowledge and expertise.
When the practice of good governance reaches the level of maturity, all owners will have the necessary transparency into their business to trust that those who are running the business are competent, fairly compensated, and accountable for the good of the whole—meaning both the company and the owners. As this perception prevails, the owners will usually align around the business strategy and management and the family business reaches its true potential for success.
There are also simply just the issues of family history—who gets along with whom and who doesn't’!
As we have detailed in the past few newsletters, succession is a difficult issue with which to deal; it is not only of economic or financial concern. There are clearly profound psychological influences involved in the process of planning the succession of a family-owned business from one generation to the next, influences such as personal vision for the company, emotional attachment to the business, business acumen, and egotism and selfishness! There are a myriad of possible issues involved in the dynamics of any family-owned business—the character and quality of the relationship of the founder with each of the children, the intrinsic level of commitment and responsibility for continuing the business on the part of the members of the next generation, the relationship between the siblings themselves and other owners, and so on. There is an entire field of counseling psychology—family counseling—devoted to working though and resolving these family-related types of issues those occur in many different circumstances, one of which is succession of family-owned businesses
Here at Sadekya our expertise is in the legal and financial aspects of family succession but we certainly consider it a good idea for any founder of a family business who is planning succession to the next generation and who believes there may be some problems associated with that process to consider involving a family counselor who is able to help the family work through and deal more successfully with any of the psychological and emotional impediments to an easy and painless succession.