Except for the most bitter divorces or hotly contested lawsuits, nothing else comes close to the intense emotions and complex challenges of engineering a succession plan for a family business. That’s precisely why so few owners actually engage in the process. Only 30 per cent have a succession plan in place, according to a 2007 study by wealth management firm Laird Norton Tyee.
Even for those who do, tiptoeing through the minefield of succession planning leads to disaster more often than triumph. Just 30 per cent of family enterprises survive a second generation of stewardship, according to the Family Firm Institute (FFI). A scant 12 per cent make it through a third generation.
“The biggest issue with succession planning is recognition of the need and a sense of urgency around doing it,” says Beth Wood, assistant vice president at Springfield, MA-based MassMutual Financial Group and supervisor of another 2007 study, co-sponsored by FFI. “Our data, based on responses from 1,035 family businesses with at least $1 million a year in revenues, suggest that almost 75 per cent of business owners are within 10 years of retirement, but have not selected a successor or put a succession plan in place,” says Wood, who runs the succession planning practice at MassMutual. “In addition, 30 per cent of the owners have no estate plan in place beyond a will. That is a concern because in our last survey, in 2002, only 19 per cent had no estate plan beyond a will. So the problem is getting worse.”
For any successful privately owned enterprise, estate taxes represent the single biggest threat to long-term well-being if not handled properly, says M. Katharine Davidson, a partner at law firm Dreier Stein Kahan Woods George, LLC in Santa Monica, CA. In Canada, probate taxes can be quite high depending on the value of the estate. As a result, one of the most important goals of a succession plan is to dramatically reduce estate tax exposure.
Many business owners mistakenly believe they have effectively addressed succession because they do, in fact, have an estate plan. “There is a huge misconception about what a succession plan is, which is why so many people do not have one,” says Ricci Victorio, vice president and a partner-director at 35-year-old succession planning firm The Rawls Group in Fairfield, CA.
“Most business owners do not really understand what a succession plan entails. Many owners think, ‘I have a buy/sell agreement, I’ve got a will, I’ve got a trust.’ Those are standard estate-planning tools. However, what they have overlooked is whether they have trained a successor and whether they have one in place. And they have not asked themselves whether they have managers and the bench strength to carry that successor into the next generation, or whether they’ve provided a way for their successor to inherit, buy or earn the stock so they have a smooth transition of ownership.”
There are also emotional and psychological reasons why so many business owners fail to tackle the issue. “People don’t like to deal with their own mortality, so they don’t like to do succession planning,” Davidson says. “They often also don’t want to deal with some of the hard questions about how to treat family members. There are always relationship issues at hand and they don’t want to disrupt family harmony. And people are so busy running their business, because that is what has made them successful, that they don’t take the time to look to the next step.”
The consequences of such neglect can be very expensive, says David Mahmood, founder and chairman of Dallas-based investment banking firm Allegiance Capital Corporation. “Lack of a succession plan can literally destroy your business,” he says. “So, no matter your age or how good your health is, you need to have a plan in place. Nobody gets out of bed in the morning and expects not to make it through the day because they will get killed in a highway accident or drop dead of a heart attack.”
David Auchterlonie, chairman and CEO of corporate turnaround management firm The Scotland Group in Newport Beach, CA, has witnessed the carnage poor succession planning can inflict. Of 200 cases he has handled over the past 22 years, about one-third have involved family-owned businesses. Of those, succession issues have invariably been at the core of the problems the businesses faced.
“The most common issue is the inexperience or the lack of capability of the designated – or designated by default – successor,” says Auchterlonie. For example, he cites a $100 million distributorship whose owner died suddenly. His eldest son, who held an MBA degree of dubious practical value, took over the company and proceeded to offer deep discounts to its best customers. That, in turn, eroded the company’s financial performance and led to a desperation sale at a fire-sale price.
Victorio agrees with Auchterlonie that a less-than-competent successor, often enabled by a sense of entitlement and the failure of rank-and-file management to expose to the owner his or her lack of qualification for the heir apparent role, is a common problem. Facing it is also among the most emotionally wrenching aspects of succession, she adds.
Yet another emotional issue, one that is often ignored, the experts say, is that the son or daughter or other family member designated as successor actually does not want the job, but a lack of communication or pressure from a parent facilitates an unfortunate circumstance that quickly becomes a catalyst for failure.
As a result, Victorio says, a growing trend is a “succession bridge,” meaning that the plan skips a generation but keeps the business in the family. Typically, an outside CEO is recruited to run the business while a grandchild completes business school and then works in a training or mentoring program under the tutelage of the interim executive until he or she is ready to assume command.
But if in doubt about the existence of a competent successor who has the requisite ambition and drive to shoulder the long-term burden of a business, the best course is usually to sell the company at the peak of its value, the experts say.
Meeting the challenge
More than anything else, perception and attitude determine the success of a succession plan. “The important thing to understand is that succession planning is a process,” says Victorio. “It is not a project. It does not have an end date.”
Key components of a solid plan include a realistic understanding of where the business is today – its strengths and weaknesses – and where the owner wants it to go, as well as a careful assessment of who is the best successor. Often, that means looking outside the family or current management team.
But the grand tradition is for a capable successor to carry on for the family and build the value of the company. Sumita Batra, CEO of Ziba Beauty, a chain of specialty salons in southern California, has endured a succession process for the past four years. Since she took over four years ago, a partnership that includes her mother – the founder of the business – husband, sister and brother has successfully doubled the size of the company, from six stores to 12.
The most important lesson Batra has learned, in going through a transition she acknowledges has been difficult at times, is that a family bond and shared trust are more important than anything else. “Blind trust must exist between the family members to come out of a process like this without damaging your family relationships,” she says. “And you have to put the emotion aside. What I learned is that you can go through a very, very tough experience and instead of getting distant, you can actually become even closer. And the business can grow and become even more successful.”