In the spotlight: “Who is business?” Focus on the next generation.
A family business is a long-term project that hinges on successfully handing over responsibility to the next generation. Mistakes can easily happen and can be very damaging. So, when you are planning succession, you have to start with a detailed analysis of the prior history of the business, your strategy and goals, before creating the optimum framework. Only then can you choose the right candidate and sign appropriate contracts. All that takes time. A lot of time.
Reading time: minutes
Director, Corporate Finance/M&A, PwC Switzerland
‘What’s next?’ This question will be all too familiar to anyone in charge of a family business. Alongside the usual things any business has to keep an eye on – the market, the competition, customers, opportunities, risks, strengths and weaknesses – family firms have to factor in another key parameter: the family itself.
The search for the best succession solution and the best successor has to begin with a thorough examination of the current circumstances. There are three dimensions to consider (figure 1). These determine the complexity of the challenge and the way the leadership structure is set up (figure 2).
a) Investment structure: the decision on who gets what share, and what happens to the remaining assets, depends on the wealth and asset situation of the family and the business. The most important factors are the number and financial capacity of the potential successors.
b) Governance structure: the question of how the business will operate going forward depends to a large extent on whether it is currently run by an individual – for example the boss who founded the business – or a board or committee.
c) Ownership structure: the future interests of a sole proprietor will be very different from those of a family dynasty. In many cases, the new ownership structure is not put in place until after the management situation has been sorted out.
Who is the right person for the job? Before you make this call, it is well worth making a comprehensive assessment of the candidate taking in not just their academic or technical qualifications or skills, but also their interests, character traits, determination, personal priorities, attitude to change, moral values and style of leadership. The biggest challenge of a succession within the family is financing. Often a young successor will not have sufficient financial resources or too many siblings to buy out (figure 3).
There are all sorts of ways for someone to enter the business. There is no right or wrong approach, although the general rule of thumb is that the bigger the operation, the more complex preparation for a leadership role will be.
a) Top-down: initially the successor sits in on board of directors’ meetings as a guest and observes the business as a spectator. At some point, they become a full member of the board.
b) Bottom-up: many aspiring family business leaders start out with a holiday job in the family firm and then do an internship or apprenticeship, or a clerk’s job in some department. From there they work their way up step by step to become a member of the management or the CEO.
c) Direct: a successor can also start off right at the top of the management tree, either as sole CEO or co-chief executive working with an external manager.
d) Indirect: another option is an interim solution to bridge a period where the heir cannot take over the reins, for example because they are too young or want to be involved on the operational side. In such cases, the company can hire an external CEO on a temporary basis, whose role includes inducting the next generation.
The business does not always have to remain in family hands. There are circumstances in which a solution outside the family might be more appropriate, for example if the children do not show any interest, do not have sufficient financial resources, or want to pursue other careers – or when there are no children. There may also be strategic reasons for looking beyond the family, for example if the pressure to internationalise, compete or innovate gets too great for the family to bear on its own. In such cases, there is the option of selling to a third party or a management buyout. This kind of approach brings a breath of fresh air and fresh capital, and depending on the situation may be healthier – both for the family and the business – than an unhappy internal solution.
In most cases, a key issue when handing over the reins is making sure knowledge and experience are transferred. Here a distinction has to be made between knowledge of the industry and management experience. Having industry-specific know-how and a grasp of the relevant technologies may make the job of managing the business easier. In this case the options include studying or doing an apprenticeship or the relevant advanced training.
Transferring leadership experience is more complex. Because leadership is down to experience and can only be learned to a limited extent, it is crucial to share experience with like-minded peers. There are specific clubs (see box) and networking seminars where potential successors can meet people in similar situations. It is easier to discuss the role and all the challenges and insecurities it involves in a forum like this than among close friends or family.
PwC’s NextGen-Club offers select events where prospective successors aged between 25 and 40 can meet and share experience with peers in a similar situation. It is important to remember that the next generation often has a different view of its role than the previous one. The NextGen-Club is a place where (upcoming) entrepreneurs can engage in dialogue outside the family and find out about new approaches. Find out more about the NextGen-Club or read PwC’s 2017 NextGen Study.
A succession always involves two people: the one who is on their way in, and the one who is on their way out. It is just as difficult a step for the one leaving as for the one coming in. Suddenly, they are faced with unpleasant issues and tough decisions. What are the alternatives? What does our dream candidate want? What do the other candidates want? When should we start the necessary discussions? What financial arrangements need to be made so that my future is secure? To get this conversation going it is well worth bringing in an external moderator or attending a workshop. Trying to find the perfect clone on your own is often destined to failure.
Below we have outlined the most important contracts needed to get a succession in shape and answer all the important questions related to financing, tax, insurance, rights and responsibilities.
a) Purchase agreement: this regulates the handover price and the legal transfer of risks and guarantees, making sure the financial and organisational arrangements before, during and after the handover are on a firm legal footing.
b) Contract of inheritance: this governs the situation in the event of the proprietor’s death. Given that this can potentially jeopardise the survival of the business, the contract of inheritance is part and parcel of the proprietor’s responsibility as an employer.
c) Marriage contract: although a marriage contract governs the relationship between two individuals, it can also have significant implications for the family business. The contract can regulate matters such as the status of the in-laws or the consequences of a divorce.
d) Shareholders’ agreement: this sets down the rights and duties of the shareholders and the way they interact. It includes, for example, the terms and timeframe for the sale of shares.
e) Power of attorney: a power of attorney ensures that if the owner is incapacitated, for example as a result of a serious accident or dementia, their affairs will be taken care of by a person they trust.
f) Family charter: the family charter sets down how a family of business owners functions and presents itself within the family and externally. It sets out the family’s values, the relationship between the family and the firm, and how conflict is handled. The family charter can serve to integrate and bind specific family members more closely to the business.
Above all, approaching succession planning systematically requires time. Most successions involve different stages (figure 4), each of which influences the others. It is usual for the process, from the first thoughts on the subject until the succession is complete, to take between 10 and 15 years.
During this process it makes sense to think in terms of scenarios. To sketch out these scenarios you need to answer some key questions. Who are you handing over to? What is being handed over? How do you make sure the arrangements are fair and equitable? What is the object being transferred? What governance structures are in place? When, or over what period, should the handover take place?
The previous history and preparatory phase are also involved in defining the purpose and strategy. At this point, you have to get clarity on the stability and fitness of your business, and the legal constraints. Fairness is a particularly sensitive issue. It involves clearly setting down the family business’ image of itself and the financial provisions for the generation handing over the reins. You also have to pay attention to the legal aspects, including addressing the key questions of valuation and financing, transaction costs and taxes.
There is no patent recipe for successful succession planning. Even so, we recommend tackling the issues as early as you can. If you are unable to get your children interested in the business or there is no candidate within the family, you have to objectively consider external alternatives. It makes sense to talk to different candidates or prospective buyers in parallel. Only by comparing them directly will you be able to work out a solution that will leave you with a good feeling when you step down or hand over the reins.
Most businesspeople only do succession planning once. Mistakes can easily happen and can potentially be very expensive or destroy a lot of value. Therefore, it is helpful to draw on the experience of experts and minimise the risk. All aspects of the succession will benefit if you bring in an outside moderator or adviser early on in the process.