Succession Planning in family owned business is about as popular as collecting debtors. Business owners know they must do it but it often gets avoided or put in the ‘too hard basket’.
In any national economy the family owned business sector is a major contributor to GDP. Within Australia, roughly 70% of all business are family owned. In the U.S. around 90% of all businesses are either owned or controlled by a family. New Zealand, Canada and the U.K. all have similarly high percentages of family owned business. And these are not just SME businesses. Almost one quarter of the top 500 private firms in Australia are family owed. They include household names such as Linfox, Visy, Crown Resorts and Hancock Prospecting. In the U.S about one third of Fortune 500 firms are family-owned.
Unfortunately, family businesses have a poor track record of succession as two thirds of them fail to make the transition from the first generation of ownership to the second. And only one half of those that make the first transition successfully will survive the transition from second to third generation ownership.
This low rate of success is generally caused by poor planning rather than some unforeseen event that catches the family unaware.
Something like 40% of family owned businesses are facing a transfer of ownership or control issue at any given time. This may be a result of ageing founders, the death or incapacity of a family member or the desire to bring in new family members to management roles in the business.
For the founder of a family business there are very few options when it comes time to ‘pass the baton’:
1. Cease trading and just close the doors
2. Sell to an outsider
3. Hire external management but retain family ownership
4. Retain family management and ownership
Whilst options 3 and 4 are often the preferred choice of the founder, frequently there is a lack of talent or willingness (or both) in the next generation to take over the family business. The statistics for failure indicate that the survival rate of businesses choosing options 3 and 4 is very low suggesting that more attention needs to be given to the issue of succession well before the need arises.
So why is the survival rate so low? My experience, both in advising clients as a CFO, and of a failed first generation succession attempt in my own family business, points to four basic factors as being the cause of most problems. They will sometimes occur in isolation and in other case there is an obvious link between them. But always, the result spells disaster for the attempted succession… and eventually the business.
The first and most common cause of failure is a simple lack of planning. For one reason or another the business reaches a crisis point and with no plan in place to facilitate the transfer of ownership from one family member to another. The resulting disruption leads to the eventual demise of the organisation.
A significant factor in many other failures is simply that the business model is not viable long term. This is common when the founder’s own personality or abilities are a critical element of business’ success. If these qualities can’t be replicated by the incoming generation there will be problem. Identifying this weakness and planning for it is critical for long term survival.
In some cases, the owner is simply not interested in handing the firm over or leaving a legacy to the next generation. He or she just accepts that when they’ve had enough the business will end. A fourth, and quite common scenario, is that the siblings have witnessed the struggle and sacrifice made by their parents to make business work and have decided they do not want to take it over.
Even if family succession is not a viable option, it makes sense for the owner of any family business to maximise the financial return from their years of sacrifice and struggle by making plans for a smooth transfer of ownership; irrespective of if that is to a family member or some third party. With the right planning in place most businesses can survive the transfer of ownership and remain viable.
There are actually four distinct plans that need to be done and a competent CFO is the ideal person to facilitate the process. Each is a discrete plan that complements the others. And all four plans are required to ensure the organisation’s long term survival after a family succession event.
A strategic plan for the business charts a course for the firm and details the goals of the business. I have written on this subject previously. Documenting the business strategy is an essential step for any business irrespective of whether or not you a family succession event is on the horizon. The plan should include as a minimum:
- long term objectives
- a good understanding of the business’ competition
- its strengths and opportunities and importantly
- it should address issues about whether cash flow should be directed towards funding growth or providing income for family members.
Essentially, the strategic plan should provide a beacon for the decision makers in the business.
A Plan for Each Family Member
This document will address issues of importance to all members of the family. It will explain the role of the family in the business, the part that each family member will play. The plan will document the governance structure that will be implemented going forward. It can state policies regarding the employment of family members, their remuneration, what happens when they leave the business and also what their entitlements are. The plan should clearly detail what support will be provided by the business to ensure family members are appropriately qualified and experienced so they can make a valuable contribution to the ongoing success of the family business.
A Business Succession Plan
The succession plan states who will take over when the present owner leaves the position and when the transition should occur. It explains clearly what role, if any, the former owner will have, what compensation they will receive and for how long they will receive it. It includes a timetable for the formal handing over of control and what remuneration the family member who takes over will receive. If desired the succession plan can include which other family members will assume board or management positions and whom, if any, of the business’ external advisors should also sit on the Board to assist with ongoing governance.
Many family businesses fail because the owner dies and hasn’t adequately planned for the event in their estate planning. The business is very often the most significant asset in an estate and without adequate planning it can be subjected to destructive taxation consequences. Estate planning for family businesses is not something that should be ignored or dealt with using a D.I.Y. will kit. I know from personal experience with clients that it is often difficult for the founders to discuss and acknowledge their mortality. But this is a critical discussion that needs to be had.
Preparing these four plans to handle the transfer of control in a family business may seem like a lot of work, and if done correctly it will be. It also requires a unique set of skills to navigate the complex issues that often plague effective communication in families. The person charged with this responsibility almost certainly needs to come from outside of the family but hold a position of significant trust and influence. This is likely to be the business’ CFO, Accountant or possibly the family Lawyer. If the process is done well, an orderly transition and continued business prosperity is the likely outcome. The alternative is acrimony and discontent within the family and the very real prospect of the business either fading away or self-destructing due to inattention.