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A Better Partnership

Publications

Oct 2001
01
October 01, 2001

Making Management Succession A Part of Your Business' Succession Plan

Succession planning is one of the most important and challenging strategic issues facing family businesses today. As the senior generation that formed family businesses in the 1960s and 1970s reaches retirement age, they are actively seeking to pass the business to the next generation. Successful succession planning requires:

  • A plan for transferring the ownership interests in the business
  • A plan for transferring the management of the business
  • A plan for addressing the financial security needs of the senior generation
  • A plan for addressing income, gift, estate, and generation skipping taxes
  • Strong family relationships

Many families focus upon the transfer of ownership, the financial security needs of the senior generation, or taxes. However, a plan for management succession often is given inadequate attention.

In today's economy many industries are faced with consolidation of customers, consolidation within their industry among competitors, shrinking margins, and competition from new technologies and global competitors. To successfully navigate these challenges requires strong leadership and management. Consequently, the ability to successfully transition the family business to the next generation is often dependent upon the ability to successfully transition management. If management succession fails to occur or is unsuccessful, the business may fail or fall on hard times, jeopardizing the financial well-being of the senior generation and the employment of hundreds of people.

So how do successful families pass management of the family business?

The Family Business Employment Policy

An important step in successfully bringing family members into leadership roles within an organization is to recognize that leadership and management roles must be earned, and not bestowed as a birthright. While some businesses can and do successfully pass the mantle of leadership to a son or daughter simply by virtue of the child’s bloodlines, the chances of success increase if the family acknowledges that these roles must be earned. One way family businesses do this is through a family employment policy.

A well thought out family employment policy will set forth the minimum criteria for employment of family members in the business, and for their promotion, accountability, and compensation. For example, the policy will require certain education and experience prior to employment that is commensurate with the position. In some cases the policy will require that family members must be employed outside the family business for a period of time and receive one or more promotions or merit salary increases elsewhere before being considered for employment in the family business.

The policy should require that family members active in the business undergo the same or an equally rigorous review process as nonfamily employees. This is an area where members of the company’s advisory board or members of an outside board of directors can be particularly helpful. As objective, dispassionate observers they can forthrightly assess the development, progress, and strengths and weaknesses of the family member. In cases where a family member might be asked to review the performance of another family member, or where a nonfamily member might feel uncomfortable reviewing the performance of a family member who may some day be able to control the nonfamily member’s employment, the involvement of an outsider might be especially appropriate.

The policy should also make clear that family members will be held accountable in the same manner, and suffer the same consequences, as nonfamily members for failing to perform at the level expected for the position. This may take the form of reduced or eliminated incentive pay or bonuses, delay or denial of promotions or increased responsibilities, reassignment, or in extreme cases, termination of employment.

Finally, the policy also should require that compensation be commensurate with the responsibilities and performance of the family member. Again, in some instances compensation will be determined with the assistance of disinterested persons, such as a trusted business advisor or a compensation specialist.

Establishing and following a family employment policy sends important signals to active and inactive family members and to nonfamily employees of the business. To family members who are inactive in the business but who might wish to be employed in the business it sends a clear message: You are not entitled to a position by virtue of your bloodline, but must earn it and retain it on your own merits. For inactive family members who maintain an ownership stake, it helps assure that their investment will be properly managed and the fruits of the business will more likely be shared fairly. To nonfamily members in the business it also sends an important message that merit is important and the existence of and adherence to the policy can assist in the retention of key nonfamily managers.

Grooming and Mentoring

Grooming and mentoring is also important to the successful succession of family members in management roles. A formalized development program gives the family member an opportunity to prove himself, hone his skills, and earn the respect of other employees before becoming an executive in the business. Over the long term this is important to both the family member and also the nonfamily employees.

For example, the child could be required to spend an extended period of time rotating through all aspects of the family’s business, from the factory floor, to engineering, to sales and marketing, and to finance before occupying an office in the executive suite. The rotation through nearly all departments in the firm can develop a respect for the skills required and abilities of the dozens of different kinds of people employed in the business and an appreciation for the tasks and challenges faced by them.

Another means of providing mentoring and grooming is to involve the child in planning sessions and to have him or her sit in on meetings to observe the development of tactical responses to difficult challenges faced by the business, even when they would not otherwise involve the child or the department in which he or she is currently employed.

Regular feedback from the nonfamily managers of the company is crucial to a grooming program and requires the founder of the company to foster an environment and relationship with his managers in which honest discussion of the child’s strengths and weaknesses can occur. For example, current managers might meet regularly with the specific agenda of discussing with the founder of the company the progress and development of the child.

Dealing with Non-Family Management

In circumstances where nonfamily members occupy key management roles, retaining these persons can present special challenges. For example, these nonfamily managers may fear the loss of their positions or the blocking of their career paths and development. Consequently, nonfamily members may be tempted to seek positions elsewhere. If this occurs before the family member is ready to assume a leadership role, the loss of key people can damage the prospects of the business.

An important step is to make nonfamily employees feel valued and to create an atmosphere where their contributions are appreciated and respected. However, even in cases where nonfamily employees feel valued, management may "see the writing on the wall" that Junior will displace or occupy positions otherwise on the career path of senior management. In some cases this may be an inaccurate perception and the concern can be alleviated if a clear timetable and set of expectations are spelled out. In other circumstances this perception may be accurate. When this is the case, a deferred compensation program (with an appropriate vesting schedule that increases the likelihood of the management member remaining with the company for needed period) can provide senior management with an incentive to remain with the business for the necessary period of time.

What to do when the Heir Apparent Isn't

What is a family to do when the heir apparent proves inadequate to the task and is not suited for the CEO role or other important leadership role? In many cases the family feels it has no choice but to sell the business, and in some cases this is the right response to the situation. However, many family owned businesses are successfully operated as family investments and led by nonfamily members. In circumstances where the business becomes a family investment changes may be required or appropriate to provide an adequate and tax advantaged source of return on the family's investment.

Conclusion

Successful passage of a family business to the next generation requires careful attention to development of the next generation of leadership and management. The chances of grooming a younger generation and developing them into effective leaders are improved through development and implementation of a family employment policy and attention to the special circumstances of nonfamily members of the management team.

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