Family Business Succession Planning

Family business succession planning is critically important but far too often ignored or kicked down the road.

Are you watching “Succession”? It’s an HBO drama on a family business that is a barely veiled satire of the succession drama that seems to have been playing out at Rupert Murdoch’s News Corp. for the past three decades. And if you have any experience in running a family business, you will be able to relate to some (hopefully not all!) of the developments.

Here in Mexico I recently became involved in discussions at a prominent-in-its-market family-owned SME, a company that is highly profitable and has operated internationally during its 35-year history.

The founder/CEO is on the verge of retirement and the next generation (a brother and sister) has increasingly assumed operational responsibility. One sibling is in charge of sales, the other is in charge of finances. Because the siblings lack some of their father’s technical and managerial acumen, the family has agreed to give equity to three senior employees with mission-critical technical and business expertise.

The family is considering forming a new business entity and they are discussing equity allocations, but they want to retain decision-making control while also institutionalizing the company to reinforce corporate governance principles. These issues are on their way to being resolved harmoniously (not always the case for family-run businesses!), but there are many considerations, and as an attorney I see (and am happy to point out to my clients) plenty of potential stumbling blocks.

So what should family-run companies think about when planning a leadership succession? There are three main considerations, in Mexico and pretty much everywhere else as well:

1. They should develop a clear (and codified) succession plan. In the case of the company I mentioned above, there was never a formal strategy for replacing the founder with his children; it just happened that one day they started working for the company and over time assumed more and more responsibility. This is not uncommon.

2. They need to develop (and codify) a business strategy and corporate governance structure. In many family businesses, decision-making is centralized, meaning the founder is the company. Which is fine. . . . until it isn’t.

3. That brings me to the need to develop (and codify) a risk management strategy. Most SMEs do not have one. That is true in Mexico, but by no means unique to Mexico. Most SMEs are reactive, not proactive, because they do not have – or do not feel they have – the resources to devote to figuring out the answers to “What if?”

1. Family Business Succession Plans 

Most obviously, the lack of a succession plan can potentially cripple a company should the founder suddenly become incapacitated or pass away. In Mexico, only 73 percent of family businesses have a succession plan, and my suspicion is that some of these plans are not very well developed. In larger and more complex organizations, or organizations in the midst of dramatic growth, a succession plan may involve a substantial change of operating procedures, i.e. the founder’s responsibilities might be split among several people.

A succession plan could include formalizing management processes; agreeing on decision-making protocols and a compensation structure for post-founder management and shareholders; establishing a training program for successor executives; and perhaps deciding to hire external managers to fill any gaps in successor management expertise.

2. Business Strategy and Corporate Governance

In my experience, many family-run businesses find it difficult to codify a business strategy because the founder dominates the decision-making process. This can be especially true in Asia, where respect for one’s elders is a fundamental social value. Also, it can be hard to argue when Pops says, “I built this!” However, the lack of a codified business strategy, and accountability to that strategy, can be a liability in running a family business and can render the company vulnerable and uncompetitive.

Governance can be lacking in family-run firms because there is little public scrutiny and low levels of institutionalization. But to be competitive, e.g. in attracting/retaining the best talent, companies must be accountable to employees, customers, suppliers, distributors and other counter-parties (including regulators). Codifying compliance and accountability processes is a vital step in professionalizing an organization.

3. Risk Management

The first risk that a family-run business must manage is the well-being of the family members running the business. I have covered this above in the succession planning section. But there are other risks that must be considered, and processes that should be codified to ensure the ongoing viability of the company and to protect it from potential liability claims (e.g. in the case of environmental issues).

Succession planning is not that different from estate planning in that it can be difficult for people to address the inevitability of change. A succession planning process driven by a founder’s desire to retire can be much easier to navigate than one driven by the next generation’s concerns that a founder is no longer up to the task of running the family business.

But as is true of estate planning, codifying the desires of all the parties with agency in the process is vital, and should be done at the earliest opportunity. And obtaining advice from trusted legal counsel is critical in family business planning issues, such as equity allocations, compensation structures and employment contracts.

One caveat: succession planning can be distracting. It is therefore important that stakeholders figure out how to ensure that the company continues operating profitably while the succession transition takes place.

Have you experienced a succession in a family-run business? Have I missed anything? I would love to hear your thoughts in the comments section below!

Read More

Business Basics, Mexico