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  • Service: Enterprise, Family business
  • Type: Business and industry issue
  • Date: 11/29/2012

How to plan for an effective family business succession 

Effective family business succession
Implementing an effective succession plan in the family business is hard. According to the Family Business Institute, only 30% of family businesses are able to do a successful transition to the second generation and only 12% achieve the transition to the third generation, when usually business disruptions and family conflicts have weakened or destroyed the family business.

The English saying “shirtsleeves to shirtsleeves in three generations” is remarkable for the number of similar versions that exist in other cultures. The Chinese say: “Fu bu guo san dai” or “Wealth never survives three generations”. The Portuguese say: “Pai Rico, filho nobre, neto pobre” or “Rich father, noble son and poor grandson”.


How can a successful entrepreneur and business owner ensure that future generations in the family enjoy the wealth and pleasure of building and stewarding their family business? This insight note summarizes some of the best practices from those Family Businesses that have done an effective succession transition…


A March 2012 article by Julius Giarmarco, published in the Journal of Financial Service Professionals, divides business succession planning into three main issues: management succession, ownership succession, and transfer taxes.

Management succession

Every business owner/founder needs to consider when, to whom, and how the management succession will be done. Failure to do so may cause severe damage to the business and family wealth in the eventuality that the founder may suddenly be unable to continue leading the business. Yet, because the issue of management succession is a vivid reminder of the founder’s own limits and mortality, it is often ignored and delayed until it is too late.


However, even those founders who have the vision to plan their management succession ahead of time may fall into several typical traps or blind spots.


A Jan-Feb 2012 article by George Stalk and Henry Foley published in the Harvard Business Review, lists three such typical traps, which even the most well-informed and best intentioned family business leaders often fall into:

1. “There’s always a place for you here”

Founders often encourage their children to pursue their own careers and interests, while signaling that they can always return to work on the family business. This approach can backfire, as the children who did less well in their own career pursuits are often the ones who want to return to the family business.


Rather than treating a place in the family business as a fallback option that the new generation is entitled to, visionary family leaders put into place a systematic process of involvement of next generation family members with the family business.


First, growing up, the next generation should be exposed to the business operations, namely as interns. Then, they are required to pursue advanced studies (university degree, even sometimes a graduate degree) and develop a successful career outside the family business for at least five years. Then they can apply to an open vacancy in the family business, in equal terms with outside candidates. The family member then needs to prove his/her worth before advancing in the family business.


This ensures a meritocratic environment, maintains the motivation of non-family managers, and ensures that only the worthy family members will have a chance to lead the family business.

2. Families often grow faster than family businesses

A significant challenge is that often the number of family members grows faster than the size of the business. A 4th generation family with each couple having on average three children could easily reach 50 members with about 30 in the next generation who could potentially play a role in the business.


This issue can be dealt with by both managing expectations about family members entry (in line with the process outlined above) as well as creating a structure for the growth of the business that allows the creation of roles where family members could prove their worth (such as new store leadership for retail firms or subsidiary involvement).

3. Homogeneity in Specialization

The authors find in their research a surprising tendency of daughter and sons to closely follow their parent’ specialization (e.g. legal, engineering, finance, etc). This reduces diversity and makes mentoring between the first and second generation more difficult due to the common area of work.


It also often delays the transfer of management responsibility as the older generation tends not to trust the expertise of the next generation (e.g. “I have 30 years of experience in Finance… my son does not know half of what he needs to know to manage this company!”).


In these cases, in addition to being alert for this pitfall, it may be useful to appoint a non-family mentor to each of the next generation members joining the family business.

Incentives for non-family managers

Overall, management succession plans should take into consideration the tremendous value that non-family managers bring to the business and their rightful expectation to work in a meritocratic environment. Employment agreements should afford key employees a certain level of stability for a transition period in the eventuality of a sudden management succession.


There should be also incentives (deferred-compensation plans, employee stock options plans or profit sharing agreements) that helps keep the long term non-family talent in the company.


To find out more, and for further reading references, download How to plan for an effective family business succession (PDF 76 KB)

 

 

Filipe Santos

Filipe Santos
Filipe Santos is Associate Professor of Entrepreneurship at INSEAD. He is the director for the Maag International Centre for Entrepreneurship and the academic director of the INSEAD Social Entrepreneurship Initiative.
 

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