The Generation Game – Planning the succession of the family business
Family businesses for decades have formed the backbone of the private sector in Ireland, with an estimated 125,000 businesses employing 350,000 people. Yet, the willingness or not of family business owners to plan for the succession process is often the decisive factor in determining whether the business will survive into the next generation or fall by the wayside. Research worldwide indicates that only one third of family businesses transfer successfully from one generation to the next generation. In effect, your grandchild has a 1:10 chance of running the business you operate today. It is a shocking statistic given that for most business owners the business is, in value terms, their largest single asset, and can represent a lifetime of personal endeavour. When you look around the business you are running today what is its future? Will what you have created, built or enhanced survive another generation?
Challenges of business succession
Two primary issues arise for private business owners:
- The complexity of the planning issues facing them is significantly greater when compared to that of other individuals of similar net worth who do not own their own business
- Balancing the family’s needs against the demands of the business
Business owners considering succession to their business may be daunted by the number of issues involved. However, approaching succession from one facet only such as tax planning or ownership transition will mean various other areas of the business will suffer and ultimately lead to significant problems.
Starting the process
Issues for initial consideration include:
- Articulating and compiling your goals as a business owner
- Identifying and consulting with key stakeholders regarding their goals
- Developing a shared vision for the business with key stakeholders
- Identifying and prioritising critical issues
Formulating a clear business strategy will help the business owner with the next steps:
- Maximise the potential of your business for growth to facilitate either a sale or succession
- Have a business plan which will drive value for stakeholders
- Provide a framework under which management can be transitioned
- Ensure that the business is in the best possible condition for passing to the next generation
Succession issues must be commensurate and appropriate to the overall strategic direction of the business. Unfortunately this is a matter which many private business owners leave to chance.
Most parents who own a business wish to pass it to their children. However, they are confronted with two critical questions: are my children interested in succeeding to the business and are my children capable of running the business?
It is extremely difficult and often painful for a parent to be objective in both assessing a child’s interest in the business and in assessing a child’s ability to run the business. Assistance may be required from non family employees or external consultants in assessing your children and determining their development needs. Determine the mix of potential family and non family management successors. Then consider:
- When you will retire, fix the date and communicate it to all key stakeholders
- Determine future business management needs and capabilities required to take the business forward
- Define key leadership positions you propose to fill
- Once potential candidates are identified, match the candidates with potential roles
- Where weaknesses are identified it may be necessary to recruit externally
- Appropriate training and development programmes should be in place for management candidates, along with:
- a mentoring system
- a performance appraisal and promotion framework
- In selecting the right successor what is best for the business often needs to be put ahead of what is best for individual family members
The next step in the management transition is to draw up transparent selection criteria for selecting a successor asking the following critical questions:
- do the candidates have the ability to move the business forward?
- do they have the leadership skills, requisite determination, focus and motivation?
- how committed are they to the business?
- do they exercise good judgement?
In determining what continuing role if any you may have, you should decide on your availability for defined transition period; and your availability to provide ongoing mentoring in assisting the next generation management team develop.
Often in family businesses ownership and management are viewed as one and the same. However, it is now increasingly the case that professional managers may be brought in to run a business with ownership transitioning to family. Alternatively, some family members could be involved in management with a wider range of family members succeeding in an ownership context.
For an owner the first question is whether to transfer ownership to the next generation or to sell and realise the value of the business.
When considering ownership transfers to the next generation it is important that they display a level of maturity and understanding of the responsibilities of ownership. Issues for consideration include:
- Will they have the business information, knowledge and acumen to participate meaningfully at shareholder meetings and contribute to decision making?
- Are they aware of long term consequences of decisions or actions they may take at shareholder level?
- Are they willing to share their thinking and decisions with other stakeholders in the business?
- Do they understand the family’s business culture, the family’s commitment to the business and ways in which they may contribute to it?
In making a decision on ownership, our experience suggests that if the existing generation consults with their children, gives them access to relevant information and seeks their opinions and preferences before reaching an overall decision, tends to lead to the most effective outcome for the following reasons:
- The successful implementation of ownership decisions often requires the involvement of those whose lives will be affected by them
- The existing generation often make incorrect assumptions about what the next generation wants for their future. Engaging with the next generation in the decision making process can lead to better informed choices
Other issues for consideration in transferring ownership to family members include:
- Knowing the value of your business
- Should I give/sell some of my interest in the business to family members or should I leave it under my will?
- If I sell the business how will my exit be funded?
- How will I fund associated costs /taxes?
Legal and tax considerations
Consideration should be given to the following:
- Updating your will
- Considering rights that spouses and children may have under succession law
- Determining whether you should have an enduring power of attorney so that appropriate decisions can be made in relation to your business should you become incapacitated
- Determining the availability of tax reliefs such as business relief for capital acquisitions tax and retirement relief for capital gains tax purposes and the overall tax cost
The complicated dynamics in a family business need to be properly managed. Communication among key stakeholders can be improved by implementing formalised governance structures. Issues for consideration include:
- Holding formal family meetings to discuss business issues. This is important where some family are in management, while some family shareholders are not employed in the business
- Establishing a family council that can make family based decisions and communicate them to those operating the business
- Framing a family constitution which can provide for the following:-
- Sets out the financial benefits each family member can expect to receive from the business
- Establishes long term goals for the family including commitments to the family business whether it is intended to pass the business from generation to generation or ultimately sell it
- Provides a mechanism for introducing the family members to the business and its governance structures
- Establish mechanisms for dealing with family members who are involved in the business including how their performance should be evaluated and their roles determined
- Provides a dispute resolution procedure
- Establishes criteria for selecting leaders and leadership transition
- Shareholder agreements which would govern issues concerning voting criteria for certain decisions, ownership of shares, how and when shares can be transferred or sold, at what price and setting any dividend policy covering value being paid out to shareholders
Your succession plan may also incorporate some of the following issues:
- Consideration on the amount of value to be held inside or outside the business
- Asset and wealth protection structuring to minimise risks to overall family wealth
- Setting retirement goals from both financial and lifestyle perspective
- Pension provision and general investment planning in respect of investments held personally or in the business
- Considering the range of associated issues involved in application of the family’s wealth generated through the business or represented by the business including any philanthropic activities; whether a family office should be established to manage family wealth; and how best to educate family members to facilitate wealth preservation across generations
Depressingly most business owners opt for the “stick our head in the sand” approach. Making sure your business has the future you would like it to have requires planning; it cannot be treated as an event you will get around to in the future or close to retirement. It is a structured process of asking questions, making plans and executing them. There is no “one size fits all”; you will need to determine what is right for your family and your business. What is important is not to wait. While succession may lie in the future, succession planning is a present necessity.
This article first appeared in the Sunday Business Post in July 2011.