Crash Course in Family Succession – Part 1
The Anatomy of a Deal Newsletter February 26, 2021
- There are plenty of specific reasons family succession plans fail, but most can be traced back to not addressing foreseeable issues head-on.
- Parents/Owners must realize that their children may not be capable of or interested in running the business and plan accordingly.
- Setting boundaries around leadership is critical- this can mean determining which of the children is “the boss” and should also outline the role of the parent(s) going forward.
- Often overlooked are the non-family employees and how a transition will affect their role in the company.
If you’re a loyal reader of Anatomy of a Deal (i.e., you’re probably a relative of mine), you know that this series almost exclusively focuses on one type of potential exit plan: the sale to an unrelated third party.
This month and next, we’re going to change things up a bit and talk about intra-family succession strategies. For many business owners, the dream has always been to pass the business on to one or more children. In fact, several studies indicate that the vast majority of business owners want to hand the business off to their children. Yet, far less than a majority actually do so.
The statistics are downright sobering. According to the Exit Planning Institute’s research, only about 30% of family-owned businesses successfully transition from the first to the second generation. And only about 10% make it to the third.
Next month, we’ll dig into some of the specific family succession strategies that we see. But before doing that, let’s explore some of the reasons why family transitions are so hard. And, just maybe we can attempt to uncover some answers that can help business owners chart a course toward success in family transitions.
With a shout-out to the glorious days of 1980s-1990s TV…
REASON 1: The Real World.
This one is pretty easy to grasp in concept, but hard for parents to accept. We all want to believe that our children are capable of doing anything. And, for many parents, there’s an assumption that our kids will have the same passion for the business that has motivated the parents all these years.
However, those hopes often don’t match with reality. If they did, my brother and I would be partners at Duffee Insurance.
Many parent/business owners can’t—or won’t—accept the reality that their kids might not really have the capability to succeed their parents in the family business or, perhaps even more distressing, that they may not want to.
Many family transitions fail because the hopes of the parents don’t align with reality. It’s time for parent/business owners and their children to stop being polite, and start getting real about the future of the children in the business.
REASON 2: Who’s the Boss?
Once we get past the first question, the next question is how to handle control issues. Unless there’s an only-child or only one child who’s involved in the business (we’ll get to that delicate issue next), there’s bound to be a question as to who calls the shots.
The easiest solution is to give all of the children equal control. There are undoubtedly cases where that works, but far more often, shared control means no control at all and the business suffers as a result.
In those cases, we tend to see two possible dynamics. First, there’s the situation where there is a “natural successor” who rises to the top and the other siblings inherently acknowledge and accept that. Alternatively, there’s a situation where there’s a constant power struggle between siblings, which usually leads to an ugly break-up at some point.
In either event, business owners need to be open and realistic about how management and control issues will be handled post-transition. Just handing equal control to multiple siblings and expecting things to work out is a recipe for potential disaster.
In many cases, the parents will choose a designated successor from among the children. While that may solve the immediate issue of ensuring that there’s someone in charge, it often creates conflict among the siblings. While that conflict may be unavoidable, it must be addressed head-on.
REASON 3: The Facts of Life.
We often use this seemingly simple question when talking with business owners who are considering family transitions: Is it important that we treat your children fairly or equally?
The question usually elicits a puzzled response. Of course, we want to be fair. And fair means equal, right?
As an example, if you have one child with special needs and one who is independently wealthy, are you being fair to both children if you use more resources to provide the necessary care for the child with special needs? That’s clearly not equal. But is it fair?
For business owners, the question of fairness vs. equality is inescapable. It may be impossible to sustain the business by simply dividing it equally among all of the children. So if one child gets the business (or control of it) while the others don’t, that won’t be equal. But it may still be fair.
There’s no easy answer to this one, but parents who are business owners need to be able to think about what’s fair to everyone. Fair to the children. Fair to the business. Fair to the business’ stakeholders.
And sometimes the business owner gets comfortable with the fairness vs. equality dynamic, but the spouse doesn’t. That’s why the spouse must always be a part of the family succession plan.
Many family transitions never happen because the parents can’t bear to make a decision that results in some actual or perceived inequality. So they sell the business to a third party or an ESOP. And that’s a perfectly fine result for many families. It avoids conflict and allows the parents to treat the children both fairly and equally.
Fair or equal? It’s a simple question on the surface, but it’s often really hard for a lot of families. And a successful family transition often hinges on the parents’ ability to separate the two.
REASON 4: Family Matters.
Business is hard. Family is hard. So, of course family business is going to be really hard.
We all have disagreements with our co-workers sometimes. But most of us don’t have to share Thanksgiving dinner with them.
And the lines between business and family will always blur. Sibling rivalries and family spats don’t stop at the company door.
When we get involved in family business disputes, we often find that the source of the conflict is much deeper than the “business issue” that’s the apparent source of argument. In many cases, the real issue has almost nothing to do with the business, but with some conflict that happened when they were kids.
When these long-standing issues fester, they threaten the business and the transition plan. They contribute to distrust. And without trust, a family succession is doomed to failure.
In many cases, family counseling is an incredibly important part of the succession strategy, but we often see family members who are reluctant to participate. Logically, they believe that they are able to separate the business from the family. Unfortunately, on a subconscious level, it’s impossible to separate business and family.
Family businesses are beautiful in many ways. But they also bring a unique set of challenges. Instead of pretending that we have to keep family and business matters separate, a family transition will only be successful when we accept that family situations affect the business and vice versa. That’s why it’s called a “family business.”
REASON 5: Charles in Charge.
Paradoxically, the biggest impediment to a family transition is sometimes the current business owner. The reason? It could be that the business owner is not emotionally ready to transition. Or it could be that the business owner’s vision for the business doesn’t match up with his children’s vision. Both are a source of continual—yet often unspoken—tension that can entirely derail the family succession.
It’s important to emphasize that we’re not talking about cultural alignment here. It’s always going to be important that the business owner and successor have a common approach to the business’ culture. However, they’re bound to disagree on a lot of things. The parent will naturally have a strong sense of what’s good for the business, forged by years of trial-and-error. The child will have a fresh perspective that she will want to share and implement.
Business owners sometimes want to keep a grip on everything that happens after the would-be transition. In many cases, that approach is destined to fail. The child quickly becomes frustrated and disillusioned with her role. Employees quickly see that the parent is still in charge and bypass the child entirely.
That’s not to say that a parent should just hand over the reins without any questions asked. A staged approach where leadership responsibility is transitioned over time can be very effective. However, it’s important to have clear expectations about that arrangement—both between parent and child and with the company’s employees, customers and other stakeholders. This is often best addressed by having a written plan with clear milestones for how the transition will take place.
And it’s equally important that the parent be comfortable with her role going forward. If the plan simply expects the parent to get out of the way and sit on the beach, it will fail. Business owners don’t simply go from living-and-breathing the business 100% of the time to 0% involvement overnight. It’s important to develop a clear life-after-transition plan for the business owner, which often will involve a real role for the business owner going forward, whether as a chairperson, trusted advisor or ambassador with employees or customers.
REASON 6: The A-Team.
So let’s say that we’ve got all of the above issues completely figured out. We’ve made it, right? Not so fast. Because there’s still the matter of how we handle the succession with non-family members.
Non-family members are a big part of many businesses. And sometimes these people are incredibly important leaders for the business. They’ve been loyal to the business owner and embraced their role, and they have important institutional knowledge and experience that will be critical to the successful transition of responsibility to the next generation.
But they’re also human.
These people may have the hardest time accepting a transition from parent to child. Some of it is jealousy; they hoped—no matter how unlikely—that they might someday have the chance to run the show. Some of it is a belief—perhaps accurate—that they know more than the child. How could they possibly be required to answer to the child now? Or, they may be fearful that they won’t have a future role with a new owner.
Another problem: they may be the least willing to express their concerns or uneasiness, for obvious reasons. Instead, we often see some leave the company after the transition, taking a lot of valuable experience and knowledge with them. Or we see some sort of persistent passive-aggressiveness that creates more damage and distrust.
The solution? You can’t assume that your key team members are fine, even if they say they are. It’s going to take some heart-to-heart conversations with these folks to understand their fears and concerns. And then, it will take some work and creativity to see if there’s a solution that can get them comfortable with their role going forward. It’s important that they know they don’t have a veto right over the transition, but that they’re still very important to the business and that both parent and child want their continued commitment to the business. Maybe those conversations will reveal that some sort of incentive plan will help get them comfortable. Or maybe it will become clear that there’s no solution that will make them happy. Even in that case, it’s better to know that now than just to assume everything is fine, when it’s clearly not.
REASON 7: Dynasty.
The last reason we’ll talk about here—though there are undoubtedly others—is simply a matter of numbers. Families obviously get bigger with each generation. It becomes more and more difficult with each generation to transition ownership and satisfy the goal of overall fairness as each successive generation gets bigger. It’s also more and more difficult to maintain a consistent message and culture as each generation stretches farther and farther away from the founder.
The decisions will become more and more difficult with each passing generation. At some point, it will probably be necessary for one sibling to buy-out another sibling, for a parent to take a child out of the business, or for the owner to ultimately decide that it’s time to sell the business. As if the family transition wasn’t hard enough on its own, the passage of time itself only makes it harder.
Running and successfully transitioning a family business is incredibly difficult. But when done properly, it can be extraordinarily rewarding, for both generations.
So why the long gloomy piece telling us all of these reasons why family transitions fail? Thanks, Debbie Downer.
Yes, it’s somewhat pessimistic. But it’s also real life. The important point is that you cannot successfully complete a family transition without addressing these realities head-on. Ignoring the difficult questions won’t make them go away.
While the tools we use to accomplish the transition are important (and we’ll address some of those next month), the first step must be setting the stage for a successful transition. The best succession plan technique will still fail 100% of the time if we don’t have the right platform in place.
And to complicate things even more, there’s no one-size-fits-all solution to how we deal with these issues. Every business is different. Every family is different. So every plan must be different as well. That’s obvious, right? Well, believe it or not, I still get the occasional phone call asking me for a “form” succession plan.
The good news? Your business doesn’t have to be just another statistic. If you’re willing to do the hard work of wrestling with the issues identified above (and undoubtedly others), you can buck the trend of failed family successions. I’ve personally had the privilege to work with a number of companies who have done just that. Their secret? Acknowledging these challenges and actively working on solving them together…not just when it’s time for a transition, but on an almost daily basis.
Read last month’s piece: Equity Rollovers 101