The survival statistics for family-owned businesses are not encouraging. Research suggests that only a third of family businesses successfully make the transition from one generation to the next and as few as five per cent are still creating shareholder value beyond the third generation.
A major factor contributing to this high mortality rate are the stresses and strains that arise around succession. Keeping control of a first generation business is rarely an issue. However, as subsequent generations become involved things get more complicated, with control and ownership potentially being shared between a widening group of siblings and cousins.
Family businesses are vulnerable during a transition period but the tensions that surround succession will continue to be present before and afterwards unless steps are taken to address them.
Common issues that arise include family members not understanding the needs of the business, or conflicting interests of different family members, for example where those not active in the business want profits to be distributed while those working in the business want them to be reinvested. Leadership is also a challenging factor as balancing the demands of the family and the business requires a combination of personal skill, business acumen and leadership, making it essential that the right individuals are selected to take control, whether they are family members or not.
There are also unspoken emotional issues including a reluctance of the senior generation to relinquish control, competition between siblings to occupy key positions and conflicting loyalties within different branches of the family.
Encouragingly, many of these issues can be addressed with careful planning. Preparation for succession will therefore give the business the best possible chance of survival.
Who controls the company?
A key issue in planning for succession is the stress between the desire to treat all children equally and the need to ensure that the business has clear leadership. One approach is to prioritise control by passing ownership to the one or two children who show most aptitude while compensating the other children in different ways (for example in cash or through giving them a separate part of the business).
This requires long-term planning to identify which children will inherit the business and to ensure that sufficient personal assets are held outside the company structure to pass to the others. This approach has the potential to be divisive unless it is taken openly and with the agreement of all family members.
Alternatively, if it is decided to allow ownership of the business to pass to the next generation without restriction, it will be important to adopt a system of governance that allows all shareholders to participate but ensures that business decision-making is not impeded. This is likely to include a shareholders agreement but may also include features that are specific to family businesses, for example a family charter setting out how the family will work together and possibly a family council to act as a link between the family and the board. Larger family businesses may also employ structural controls such as the establishment of a dual board structure or the use of a family holding company.
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A significant factor in the success of either of these approaches will be selecting and educating the right individual(s) to take control. This is a long-term process and to be successful needs to be fair, transparent and carefully designed. An impartial and open process, preferably involving input from one or more trusted non-family directors, will have several benefits. Primarily, it will help to ensure that younger family members have confidence in the outcome and neither leave the business out of frustration nor feel aggrieved if they are not selected. An impartial system will also help to remove personal conflicts that existing managers may feel when making decisions involving family members.
Tax and financial planning
All family members need to understand the requirements of the business and have a clear view of what they can expect to receive, through salary and dividends. Careful personal financial and tax planning will also mean that retiring members can ensure that their finances are in good shape by the time that they plan to retire. This means that they do not need to stay in the business longer than intended and that there is a tax efficient way to pass control and ownership to their children without leaving them (or the business) burdened with debt or crippled by Inheritance Tax.
The common factor for all of these issues is the importance of forward planning. Succession is not necessarily the right answer for all family businesses. If none of the next generation is interested in joining the business there are other options, such as recruiting professional management, but these take time if they are to be achieved properly. Succession planning starts with identifying all the options, discussing them openly, agreeing the best course of action and implementing it. The key to giving the business the best chance of thriving into the next generation is to think about these issues as early as possible.