While the majority of family business owners would like to see their business transferred to the next generation, it is estimated that 70 per cent will not survive into the second generation and 90 per cent will not make it to the third generation (Family Firm Institute).
These are sobering statistics for anyone involved with a family business.
Why do family businesses struggle so much with survival beyond the first generation?
The underlying reasons are varied as family businesses face a unique set of stresses and strains. However, there are steps which every family business can take to increase their chances of survival.
It is common for family businesses to struggle with communication as there is often no clear boundary between family and business relationships. Poor communication quickly leads to misunderstandings, which increase business and family tensions.
It may be useful to document how family members should act in relation to the business in a family constitution or charter. This can set out how family members want the business to run, the longer term strategies of the business, the family’s aspirations and how family members should behave towards each other.
Some may question the value of a family constitution as it is usually non-binding. However, properly used it can establish a boundary between family and business relationships and help to manage people’s expectations (including surrounding succession and control) which can take the emotion out of the decision making process. Larger family businesses may also consider establishing a family council to enable family members who are remote from the business to remain involved with, and loyal to, the business.
Fairness and transparency
Who deserves the pay rise or promotion? Who is to be selected for a key role? Which sibling is more suitable to take on leadership of the business? Your decisions may be right for the business but may still lead to resentment if not properly managed.
To reduce the risk of conflict it is important to have a fair process for decision making, which is clear and consistent. There should be parameters in place for pay rises and promotions so that it is clear why somebody is being rewarded. If there is a vacancy in the business, the selection process should be based on merit – including considering whether a non-family member may be the best candidate. Business policies may also include the selection and training of successors so that they are coached and assessed prior to taking over key roles. A well-drafted family constitution can deal with all of these issues.
Clear retirement and handover plan
Most business owners are happy to talk about what they are going to do when they retire but in reality many do not like the thought of retirement and few have a proper plan. Succession can be a vulnerable time for a family business and it is foolhardy to devote years to building a business but give little thought to such a key moment.
In a recent PwC family business survey, 87 per cent of the next generation felt that their parents had confidence in them and 91 per cent would value their parents’ continued input, but as many as 64 per cent think the current generation will find it tough to let go (Next Generation Survey, 15 April 2014).
Be clear whether anybody in the family wants to take over the business. If there are no clear candidates then it may be necessary to consider alternatives. This might mean recruiting and training a professional (non-family) management team or considering a sale of the business. In some cases it can be worth offering family members the opportunity to work in the business for a short period to help them make an informed decision.
It is also important to plan financially to ensure that you have enough money to retire. The earlier this planning process starts the better.
Professionalising at the right moment
The term ‘professionalising’ is much used when referring to family businesses. It can mean different things to different businesses, but it may include:
- Incorporating – Making the transition to a company limited by shares;
- Board of directors – Establishing a fully functioning board of directors who are capable of leading the business, even in the absence of the founder or other key family members; and
- Employment of non-family members – Introducing new talent from outside of the family.
Control the circle of ownership
Avoiding the dilution of family control is a challenge faced by all family owned businesses. Who can own shares in the business and what rights will they have? Will shares will be inherited by future generations or will they be bought back by the family or the company? A robust shareholder agreement should answer these questions. Business protection is also necessary against unfortunate events such as death or divorce. It is important to review regularly whether the shareholders’ Wills properly reflect their intentions and whether they will work in practice. For example, if a Will conflicts with automatic share transfer provisions in the company’s article or shareholders agreement, the latter are likely to prevail.
Every family business will have its fair share of both family and business issues. It is often said that “family businesses usually fail for family reasons”. To protect your family business from being the victim of these issues it is important that the difficult questions are addressed as early as possible. There are no secret formulae but running through the points above and taking a hard look at your business is a good starting point.
Richard Hughes is a commercial lawyer in Burges Salmon’s family business team.