A successful family business is often the sole basis of a family’s wealth and getting the succession planning right is important to preserve this wealth. It can generate sufficient income to support multiple generations of the family and can be a source of enormous pride and identity for the family members.
When the founder begins to contemplate retirement, or becomes unable to continue working in the business for some other reason, it is quite normal that another family member is the first choice of successor. Whilst this may sound quite easy to do, it is a process that requires time and good planning if you want a smooth transition.
In my experience, most business transitions are not contemplated early enough nor are they very well-planned. The statistics show that more than half of all second-generation business fail in the first three years after the next generation assumes control, and fewer than one in five of those that do survive will make it into the third generation. The financial impact on a family can be devastating and be the difference between “relative wealth” and “struggle street” for successive generations.
It’s important to remember also that it is not only the family members who will be impacted by this succession event. The successor will need to develop new relationships with the employees, suppliers and a range external advisors. Many of these people will have invaluable knowledge and experience that needs to be retained in the business so this transition is just as important as managing the impact on family. Much of this knowledge will not be documented anywhere and its transference is best done in an orderly and gradual manner.
Plan the transition date – but don’t be rigidly locked into it
The process should start with setting a date for when the outgoing generation would like to go. There is a myriad of reasons why it may not happen on that date but without an established time frame the work needed to prepare for the event may never get done. Often the date has been based around a significant birthday or anniversary of ownership. The actual reason is unimportant; but setting a date is critical.
Selecting who’s next in line
Choosing a successor should always be merit based. Selecting a person based purely on the fact that they are the oldest sibling or may have worked in the business the longest is extremely unwise. Approach this decision in the same way you would if you were advertising for someone outside of the family to take the role. The skills required to manage a business are quite different to those required to merely work in the business. Sadly, family dynamics can often mean that the wrong person is chosen to succeed an outgoing owner and this is a major reason why over half of the second-generation businesses do not make it to a third.
When assessing potential family members, make unbiased assessments of their strengths and weaknesses and suitability for the role. Remove issues such as family loyalty or favouritism from the selection process and make the decision based purely on the candidate’s management capabilities and overall business acumen. These qualities are far more important to the ongoing success of the business than “knowing the business back-to-front”.
Enlist the help of your family accountant or virtual CFO as they will know what is required of the successor and will likely have had exposure to the potential candidates to provide impartial feedback on their suitability.
Preparing them to control
It is likely that during the process selecting of a successor some knowledge gaps or weaknesses will be identified. The time to address these is before they assume control of the business. Depending on the nature of the training required it may take many months or even years to achieve.
If the successor has only ever worked for the family business, then some of their best learning can be gained by working in another business. They should be encouraged to take a sabbatical, away from the family business, to gain experience in different roles and industries.
If a specific qualification, requiring several years of study is needed, then consideration needs to be given to who should pay for this. It may be that some mentoring will also assist in their development so the selection of an appropriate mentor is important.
How to pay for the business
If the outgoing owner of the business needs to fund their retirement from proceeds of the transfer of the business, the terms of this should be clearly understood and documented just as would be the case if it were being sold to someone outside of the family. And managing this without adversely affecting the cash flow of the business will give the incoming person the space to learn without being distracted from having to micro-manage cash flow problems.
Set up an advisory ‘board’
If several family members are involved in the business it can be helpful to set up an advisory board to meet regularly and discuss what is being planned with the transition. This can often help alleviate feelings of disappointment about being overlooked for the role. Once you include non-family members on this board with a range of skills and experience you are well on the way to establishing a good governance framework that will also serve the business well after the transition has occurred.
It is good practice to take notes, or minutes, of these meetings and distribute them soon after each meeting to avoid the possibility of later disagreement about what was said or decided.
Estate planning and Tax
The succession process must also include consideration of estate planning and taxation consequences. These two areas of law are extremely complex and best left to the relevant experts. The consequence of not seeking proper advice can be the unnecessary loss of tax concessions – resulting in you paying more tax than necessary.
About David Officen
David is the Founder and Managing Director of proCFO. David combines an accounting and consulting background with commercial experience both as a manager for large commercial businesses and as the owner of private and family businesses.