Three Scenarios for Family Business Succession
Families should always be looking to identify and deliberately prepare successors for leadership and management roles among the rising generations. This is a core practice for effective family business governance and risk management. It’s also important to have a contingency plan in case of the unexpected, such as if the designated heir is unable to fill the role for any reason.
There are three main scenarios for how the succession of leadership and management proceeds, and each one raises distinct questions that must be addressed:
- A family member has been identified to take over, and they’ve had thorough preparation along with participation in the family business. How can you best set them up for success in terms of planning and communication around the transition?
- A family member has been identified to take over, but they might be too young or don’t have the skills yet. How can you vet them to determine readiness, and what do you do in the interim?
- No family member wants to take over, no one is prepared or no one is qualified. What is the process to pick a non-family successor or determine the future of the business?
Scenario #1: Facilitating Success for the Chosen Heir
This is the most straightforward scenario: Deliberate succession planning has proceeded as envisioned, and the timing is appropriate. The identified heir should have already gained the requisite education and experience in terms of finances, business acumen, leadership and decision-making. This preparation and training will have positioned them to fulfill the key duties for a leadership role.
While these conditions are ideal, steps still must be taken to put the heir in the best position possible upon takeover. It’s critical to communicate the succession plan to all key stakeholders on an appropriate timeline, which helps to bolster confidence in the family’s plan and maintain continuity during the transition. Compensation is an important element to review, and it should be commensurate with the heir’s skills, experience and performance relative to similar roles at other organizations.
It’s also important to establish a new role for members of the older generation who are handing over control. One option is to form an advisory board that includes members of the older generation — as well as others, potentially closer in age to the heir’s peer group — for major decisions or to help guide the new leader until they mature in their position.
Scenario #2: The Heir Isn’t Ready and an Interim Plan is Needed
Timing is a critical variable in any succession, and the lifecycle of the family business may not line up completely with plans for the chosen heir. In these cases, a non-family individual may be necessary to fill a leadership role on an interim basis. This could be a good opportunity for an experienced person near the end of their career or for someone who is already part of the business but seeking a temporary role.
When placing a non-family individual in a leadership role, it’s especially important to have a mutual understanding of the family’s interests, goals and the expected timeline, which will help maintain alignment and avoid potentially damaging miscommunications. Critically, this non-family member should also be prepared to mentor the chosen heir and facilitate their future transition into the role.
Compensation for a non-family member in their interim role can be a complex consideration, and most family-owned businesses will not want to surrender equity. Although an ownership stake can help link incentives to business performance, there are other options to achieve this. For example, a phantom stock agreement can tie compensation to business outcomes without giving up equity. In any scenario, compensation should be reviewed closely and be subject to board approval.
It’s also not strictly necessary to find an outside candidate, and, in certain cases, the senior family member may simply maintain their role for longer than initially planned. Then they can transition the selected heir into the role when ready without bringing in a non-family individual to a leadership position. If this occurs, the senior family member still must accept that they will eventually need to give up control. An updated timeline should account for that, and new contingency plans should be made to remain adaptable. This process of deciding when to transition leadership to the rising generation can be similar to creating a will and organizing for the next phase; it’s often put off for a later date, but it’s beneficial to be proactive.
This scenario can also be a trigger to sell the business, depending on the unique circumstances of the business and family. The timeline and assessment of the chosen heir’s readiness for the role may be a determining factor. Ultimately, dutiful succession planning in advance should have specifically outlined the leadership traits, professional experience and business acumen needed for the role, along with methods for assessment. These criteria will help evaluate the options and inform the decision-making.
Scenario #3: There is No Heir and the Family Must Decide About the Future
Sometimes, for a variety of reasons, there is no heir identified or available to fill the role. Then it may be necessary to select a non-family individual as a successor for long-term leadership and management. If so, the family will still want to retain ownership and control while also ensuring continuity for ongoing success.
In this case, the process will be similar to identifying an executive candidate in a business. It requires a clear description of the role and a defined set of expectations for the candidate to fulfill, but it’s imperative for them to establish trust and confidence with the family and key stakeholders in the business. Clearly outlining their responsibilities and confirming the experience and ability to carry them out, will prepare both the family and the candidate for success.
However, lacking an identified heir can trigger difficult decisions about the future of a family business. Selling the business or going public could be viable options, depending on the family’s goals and circumstances, as well as the overall outlook for the business and industry. In some cases, ceding control may be the best way for family members to “cash out” and maximize value, but there are many options available, including tapping current non-family executives.
Bringing in non-public investors who can provide both capital and expertise can also help continue business operations, and their compensation can be structured in a way that avoids giving up equity and maintains full ownership. Particularly in this scenario, it’s important to link compensation to business performance without yielding equity, and a phantom stock agreement is one way to achieve this. Ultimately, there is no single solution for this scenario, but deliberation among all key stakeholders will help to weigh the options and decide upon the best course to address the family’s goals and values.
|MFA’s Exit Planning Team has extensive experience guiding business owners and their families through the succession and exit process. Whether you are passing the torch to a family member, testing the M&A market or planning for another exit strategy, our team is here to help you understand the key considerations and implications. Learn more about our Exit Planning Services here and contact our team for more information.|
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