Succession Planning in a Family-Owned Business

Over the years we have helped many owners of family-owned businesses plan for, think through and execute the transition of their businesses to the next generation – be it the next generation of the family, the next generation of management or the next generation of ownership.

In all cases we noted one common weakness: they started the planning when they already had a transition date in mind.

Why is that a problem? Because they were looking for a plan to execute rather than pondering the philosophy that should drive the plan. In other words, if you haven’t yet started thinking about this, it might already be too late. Let’s elaborate.

During any management transition in a company, chances are that, in the short term, the income statement is preserved. But the balance sheet can be destroyed, unwittingly and unnoticeably.

I don’t mean the financial assets or even the tangible assets of the balance sheet, but rather the intangible assets that were never recorded on the balance sheet. After a management transition, people will still continue to bring in the orders, produce the products, deliver the services and keep things running. But that only ensures that the income statement for the next few periods is protected. Meanwhile, the brand of the company, its corporate culture, the feel of working in this company, company morale and employees’ engagement are all affected. If the company was successful before the transition, then after the transition these intangible balance sheet assets can (at best) be protected or (at worst) destroyed. This is all the more important in a transition of a family-owned business, because the success of the transition and the legacy of the family are closely linked. Planning for this success should begin long before planning for the transition. It should begin with the philosophical intent.

There is a difference between the philosophy behind a plan and elements of the plan.

Let’s illustrate with three examples. One client who thought through his succession wanted to ensure that the culture of the company stayed intact. At the same time the owner was looking for a graceful exit strategy to liquidate his equity. How can you sell the company to somebody else and yet require that the culture stay intact? He found a solution!

Another client wanted to transfer the company from one generation of the family to the next. Though they wanted to transfer the equity and management, they wanted the “patriarch” to stay in a consulting role. “Is that possible?” they asked. This company found a solution, with partial success.

Yet a third company wanted to create an exit strategy for the owners while preserving the operational culture as a strategic selling point. The company has since been sold, and the owners tell me the parent company has now adopted some of the cultural practices. In all three cases, the owners had a clear philosophical intent which drove the creation of the plan.

So what is the secret? Actually, there are three secrets. Start long before you think you need to start. Think philosophy before thinking about a plan of action. Stop comingling management transition with ownership transition. We offer a seven-step process, assuming you are starting this process long before you have to execute it.

Step 1: Understand what matters to you.

If your answer is “liquidating your equity,” or “taking care of the people,” etc., you are not digging deep enough. How do you dig deep? Consider this morbid exercise. Imagine what you will think about during the last 24 hours of your life, just before your natural death? Can you play that out in your head today? For most of us that is too uncomfortable. As an alternative, we suggest an exercise called Inspired Imperatives, a collection of fundamental beliefs you hold dear and would be proud to have lived by. We use this technique in our Beyond L³ program, the graduate level course beyond our leadership program. Whichever exercise you choose, the outcome should create a simple list of what matters to you. This will serve as the foundational philosophy to create a succession plan.

Step 2: Build bench strength.

Most CEOs of successful family-owned businesses are natural leaders who have never given thought to their style of leadership. One consequence of that lack of intentionality is that those CEOs have not caused others to become intentional leaders. They typically do not have bench strength. The most common limiting agent for a growing family-owned company is neither market opportunity nor investment capacity; it is the limited leadership talent below the CEO. Senior leadership frequently focuses so exclusively on the growth of the company, that it often neglects growing its internal leadership, the fuel for continued growth. So focus on developing intentional leadership throughout your organization.

Step 3: Articulate the company story.

It is important for companies to have an organizational narrative. Most family-owned companies have a story; it usually starts out with how the company was founded and how it transformed over generations. Initially the company and the family were comingled. The purpose of the company was drawn from the purpose of the CEO. In most successful family-owned companies, the CEO is a benevolent patriarch. (We use the term patriarch as a gender-neutral noun.) The vision of the CEO is adopted with enthusiasm. The company story, not only of its origin and the founding family, but the source of its core purpose, the simple vision of a world it sees in the future, the mission it has adopted to bring a portion of that vision to reality, and the core values that govern the behavior in the company, all need to be woven into an organizational narrative. The CEO carries it in his or her head today. It needs to have life in the future.

Step 4: Institutionalize the company culture.

Most successful family-owned companies have an implicit culture, usually driven by the benevolent patriarch who is viewed as the caretaker of this culture. The elements of the culture are implicit understandings which, over time, have created implicit cultural pillars. For example, respect for leadership might be a cultural pillar that has always existed, usually because of the respect for the patriarch. A collegial atmosphere might be another such cultural pillar. But these cultural pillars usually have shadow side weaknesses. The shadow side weakness of respect for authority might be self-imposed lack of empowerment, where middle management does not do anything until checking with senior leadership. A collegial atmosphere can create a shadow side weakness, where it is not considered acceptable to disagree with someone in a meeting. During the management transition in a successful family-owned company, the pillars can crack, leaving the shadow side weaknesses exposed. Family-owned companies are also known for creating a loyalty-based culture. Is there an intention to remain loyalty-based? It is incumbent on the patriarch to institutionalize an intentional culture that will outlast the patriarch, and in the process ensure that the shadow side weaknesses are mitigated.

Step 5: Develop an equity transition plan.

Do not comingle the transfer of equity with the transfer of management. They are two separate items and should be considered separately. They might interweave, but they should do so intentionally. Is the equity going to be transferred within the family and, if so, by gift/inheritance or by purchase? Engaging a competent financial advisor to facilitate this conversation with all parties concerned can make these awkward discussions more forthright and directed. Is the equity going to be transferred to management and, if so, what is the timeframe and who are the participants? Is the equity going to be sold to an outside investor and, if so, has the family reconciled to its consequences? Has the family considered an ESOP arrangement? All of these questions should be answered in the context of the philosophy established in Step 1 with an independent professional advisor that is able to articulate the pros and cons, independent of the management transition plan.

Step 6: Develop a management transition plan.

Is management going to be transitioned to another family member or to an outside CEO? In either case, will the new successor be in residence apprenticing for the job? If so, will the plan be put in place, communicated to all parties concerned – including the top leadership – and allowed to be socialized by the company before the transition occurs? Are there constraints placed on the new management? For example, the family might have a requirement that the plant in their small town not be disrupted, or that a certain customer, product or employee is off-limits and the new management cannot discontinue their engagement unilaterally. Although these requirements can be purely emotional, they must be clearly communicated. The patriarch also needs to be clear with the new management as to the extent of involvement he/she intends to have. This plan should be in place before a successor is chosen.

Step 7: Execution.

Now you can begin to talk timeframe and execution. Clearly, in each item of the previous steps there are execution elements. Put all of those execution elements in a PERT chart so that dependencies become very clear and the critical path becomes evident. Use that to decide on a timeframe and lay out the action steps that need to occur.

We have used elements of this plan with various clients. If you’re facing this challenge firsthand, we would be happy to discuss more details of these steps with you.

Food for Thought is our way of sharing interesting concepts on corporate leadership and management with others who might find it useful. The thoughts offered are intended to be controversial and thought-provoking. They are intended to help our readers intentionally realize their potential, what we call Potentionality.