Why do a large percentage of family businesses fail when transferring to the next generation?

BMW, Samsung, Fisher and Paykel, Michael Hill International, Smith & Caughey and Walmart are examples of highly successful multigenerational family businesses. Although around 75% of businesses in New Zealand are family-run, the statistics paint a sombre picture for the success of these family businesses surviving into the next generation. What makes these businesses so susceptible to failure?

Although the reasons are varied, you will find several common themes.

Lack of involvement and business education of the younger generations

How can you expect your successor to take over and run your business successfully if you haven’t spent time training him or her?

  1. The failure to actively educate the younger generations around finances and business concepts have resulted in many children being ill-prepared to manage money or to step into a business management role in their parents or grandparent’s business.
    1. By not nurturing a sense of responsibility, history and core family values the next generation lack the understanding of why.
    2. With no education in the Family Business, it is more likely they will have poor decision-making skills. The result is that the family’s capital can be put at significant risk and ultimately the business could fail.
    3. Planning to move the family business between generations will have a greater chance of success if you work for a year or two with your successor(s) before you hand over the reins.
    4. There are excellent benefits for a family business if your children are encouraged to experience working in other unrelated companies, where their abilities can be grown away from the family.
Neopotism

Families who continue to promote unqualified or under qualified relatives into positions of power just because they are members of the founding family are also on a fast-track to failure.

  1. Rather than making your own decisions on who will run the business and then announcing it to the family, a technique we have found to be one of the surest ways to sow family discord, it would be wiser to look at your family realistically and plan accordingly.
    1. Examine the strengths of all possible successors as objectively as possible and think about what’s best for the business.
    2. Do your children or nieces or nephews have the business skills or even the interest to do it?
    3. Consider what happens if there are no family members capable of continuing the business. If this is the case, then your plan needs to focus on the sale of the business at a future point or at least an independent CEO reporting to a board which also contains independent, experienced directors.
    4. The moral of the lesson is to involve your family in business planning and succession discussions.
Case Study 1

One family business we were working alongside was in the process of transferring the management between generations. There was an open dialogue between the generations to ensure that the “child” wanted to acquire the business and understood the financial ramifications.  It was vital that it was the child’s wish to purchase the business and not that of their parents which were forced upon them or imputed to them.

In this case, the child’s principal concern was financial, i.e. what happens if they could not maintain the business and as a result not be able to service the repayment of the debt to the parents?  This can be handled so that perhaps the debt is limited recourse, but the negative is that then removes a valuable asset for the other children.

Typically, the family business represents a very high percentage of the wealth of Mum and Dad when we come to look at succession issues.  If they want to transfer it to some but not all of their children, then it is important that equality between the children is considered.

A lack of family governance structure

Governance issues are avoided by many families because it forces them to confront the possible need for significant changes in how they manage their business. Without a robust framework, family business are easy victims to internal discord and ownership issues down the track.

  1. Governance structures formalise precisely who does what and how.
    1. Having a structure provides a distinct line between family and business, separating family control from the daily management of the business.
    2. Independent, experienced directors and advisers need to be part of this to provide an independent, removed and unbiased perspective.
Failure to start business succession planning early.

By delaying retirement and avoiding putting in a succession plan in place can be further exacerbated by an unexpected illness or sudden death which provides real risk to the business and the family’s financial health.

  1. Planning long term is good. The longer you get to spend on succession planning, the smoother the transition process is likely to be. Consider five or ten years in advance at a minimum.
    1. Proper succession planning can take years whether you bring in outside managers or train up an internal successor.
    2. Succession must look at both planned and unplanned scenarios, the later including situations where a parent or senior family member meets an unexpected and untimely death or disability long before their planned retirement.
Trying to be fair to all 

Get over the idea that everyone must have an equal share or even an equal say. Just because you are a family member doesn’t mean you will get a top job in the company unless you are qualified and competent to do it.

  1. In any business, management and ownership are not necessarily the same thing. For example, you may decide to transfer management of your business to just one of your children but transfer equal shares in the business to all of your children, whether they’re actively involved in operating the business or not.
    1. But trying to be “fair” is a nice idea in theory, but it may not be in the best interests of your business. It may be fairer for the successor(s) you have chosen to run the business to have a larger share of business ownership than family members not active in the business. Alternatively, it may be better to transfer both management and ownership to your chosen successor and make other financial arrangements to benefit your other children.
    2. Another option would be to bring in professional managers to run the business while retaining ownership in the family as a whole. Many successful multigenerational family firms do this as it allows them to focus on diversifying and managing their wealth as well as making it easier to navigate generational transitions.
Case Study 2

In this example, the family business was a farm where the “child” that worked the land had got into the ear of Mum and Dad’s independent trustee who also happened to be his chartered accountant.  The parents, owners of the land and farm operation, were convinced to sell it to the child at a low price with extremely concessional repayment provisions including that no repayment of the principal was to be made for ten years.  While there was interest to be charged, again it was concessional.

A large part of the value of the farm was being transferred to a child without equal consideration for the other children.

At the last minute, Mum and Dad did realise there could be an issue and arranged a family conference where the whole exercise was sprung upon the other three unsuspecting children who, to say the least, were somewhat gobsmacked.

Epilogue….In a similar situation, we came across recently a “child” had been sold the family farm at a significant concessionary value. Two years later that child then turned around and sold the farm at an exorbitant profit. The sale and the significant profit made on the sale fractured the family as the first sale had no clawback provisions for subsequent sale profits built into the agreement as the expectation of the parents and the stated intention of the child was to farm for life

When you are dealing with children and potentially transferring an asset to one of them and not the others, the critical concern is to ensure that there is a perception of equality and fairness.  Even if there is to be some benefit for the child, in recognition of past service, endeavour or the like, it is essential that this is discussed openly and in a proper forum within the family or it has the potential to divide the family and poison relationships for the future.

Succession will continue to be one of the principal issues for families owning businesses.  With many baby boomers reaching retirement age, what they do with their business is increasingly weighing upon their minds.  Do they sell the business to third parties?  Do they transfer it to the next generation?  What should they do with it?

For most, there is never one single right answer to this but what is important is to work through a process so the family can see the options and understand the implications of each. 

As always, we are here to assist.