Published Wednesday, August 9, 2006 at: 7:00 AM EDT
For anyone who has built a business, transferring control can be a nightmare scenario. When the kids step into your shoes, rather than nurturing and expanding the company, they battle each other for control, and the business sputters and eventually dies. “Succession issues can evolve into a legacy of conflict,” says Kevin Schulte, director of the Jefferson Smurfit Center for Entrepreneurial Studies at Saint Louis University’s John Cooke School of Business. Internecine strife is one reason fewer than a third of family-owned businesses makes it to the second generation, and a mere 12% remain in family hands by the third, according to the Family Firm Institute, a research company in Boston.
Why some family firms survive the transition while others lose their way often has as much to do with family relationships as with management skills or business plans, says Schulte. Conflicts may arise when children lack the talent or experience to become the next chief. Or the founder may stubbornly hold on to the reins or let a compulsion for equality among children color his or her judgment. For example, to be equitable, an owner may split ownership equally among three children—and thus guarantee that the one who actually runs the company will have only a minority interest and could be overruled at critical junctures by the two siblings who together hold a controlling stake.
Careful succession planning that addresses legal, accounting, and insurance issues can head off these and other transition problems, says Schulte. But it’s important to get an early start, he adds, cautioning business owners not to wait until late in life when the need to couple succession planning with estate planning can create additional pressures, particularly if a founder is facing long-term illness or disability. “If you plan ahead, you can talk to your children about how they may fit into the business, identify what skills they have, and what they need to do to advance,” Schulte says.
Putting together a succession plan forces you to contemplate what the business will look like after you depart—a difficult but essential part of the process—as well as which of your children may be the best choice to succeed you. Founders must demand that an heir who wants to take over be truly passionate about the business, says Schulte, and be realistic about whether such sustained passion can be expected. In addition, any would-be successor should have solid training and the experience of working for someone else for three to five years. “Outside experience adds credibility when the heir comes back to work in the business, especially if that experience includes technology or management expertise,” he says. “That helps heirs gain support from the company’s other professional managers, non-family members who are vital to keep it running.”
Some children, of course, won’t be interested in working for the company at all, and that presents both succession and financial planning issues. If nobody within the family particularly wants to run the business, you’ll need to groom a current employee or bring in an outside professional, says Schulte. Then, conflicts may arise between family owners of the business and the people who are running it. To keep management and operational decisions insulated from family politics, Schulte suggests creating a board of directors that includes experienced non-family members and an odd number of seats. “You need a tie breaker,” says Schulte. “And you want outsiders who can say, ‘Wait a minute, we think things are too focused on the family and not enough on the business.’”
Making a transition work will require technical expertise from a variety of sources. For example, a business that needs to provide cash for heirs not actively involved in the company could call on legal and financial advisors to create an irrevocable life insurance trust. And if you’re selling a family business to an outsider or a group of employees, you’ll need a professionally drafted buy-sell agreement that addresses tax and liquidity issues, says Schulte.
Deciding what will happen to your business when you leave and committing the plan to paper is essential, says Schulte, but it’s unlikely to be a once-and-done proposition. “Succession planning is often described as a journey, not a destination,” he says.
But it’s a journey you can hardly afford not to take, says Schulte. Knowing that the business you’ve built is well prepared to go on after you step down can be enormously satisfying, and a succession plan can ensure that your children benefit from the success of the business whether or not they are actively involved.
This article was written by a professional financial journalist for Advisor Products and is not intended as legal or investment advice.