We all know that relationships are very important in our lives. This is true in our family as well as our business lives. In my practice, I have dealt with the various dynamics on the transfer of a family business after the family’s senior generation passes on the business to the next generation hoping that it will continue on. I have been involved in protracted family discord where there is the breakdown in the business side of the family relationships. This is particularly true where there was a lack of understanding who will be in charge of the business or the failure to deal with a family member that has always been a challenge to the family for whatever reason.
Most of the time things go well and there is no in fighting at the next generation if the senior generation takes the time to build a workable relationship. This is true if there have been regular family meetings where there is an understanding of the family business and what will happen in the future.
In a recent article written by Avi Z. Kestenbaum in November 2014 to tax professionals, his research showed that the lack of a workable relationship represented 60% of the most common failures for successful business succession transfers. The balance of this article is based upon his research and comments.
Only 30% of family businesses successfully pass to the 2nd generation, 12% to the 3rd generation, and 3% to the 4th generation. In almost all instances this failure is not due to lack of tax planning or imposition of taxes. The analysis of family business succession failures indicate that of typical breakdowns of family businesses: 1) 60% arise from relationship issues (how they get along); 2) 25% from lack of competence and being unprepared; and 3) only 10% due to tax and traditional estate planning issues.
There are natural and inherent conflicts between family and business. They include:
- families value tradition and resist change while businesses succeed and grow during changing times;
- families are emotional while businesses are logical;
- families seek equal treatment and rewards while businesses reward based on performance and responsibility; and
- families accept members unconditionally while businesses rank employees and fire those who are not productive.
The senior generation often times must balance the competing goals of securing the future success of the family business with family unity and well-being and often times trying to accomplish both objectives leads to worse results and neither goal being fulfilled. This is a very difficult and emotional decision and many of our clients are torn between doing what is best for the future of the business and upsetting some or all of their family members.
Most of the succession issues are unique to family businesses and have little application to other assets. Cash and brokerage accounts are easy to divide among the heirs or in trusts for their benefit. Real estate can sometimes be divided through different parcels, or as a mostly passive asset, can sometimes (albeit with difficulty and often times there are also major family disputes) be held together many years for the family’s benefit through a family management committee or with outside management companies. In contrast, operating businesses cannot generally be divided and must be very actively managed to stay current and profitable.
Successful Family Businesses Outlined below are the most common characteristics shared by family businesses that have been successfully passed down more than one generation:
- Positive Family Business Image
- Code of Shared Values
- Entrepreneurial Risk Taking Through the Generations
- Market Niches
- Self-imposed Capital Restraint in Second and Third Generations
- Commitment to Charity and Community Development
- Family Unity
- Commitment to Legacy
- Written System of Governance and Conflict Management
Family Unity Family unity is one of the most essential traits in successful family businesses.Unity in the family is achieved through a combination of several possible means, including: having a shared vision and expectation for the family and the family business; cooperation in regular family meetings; commitment to continuing the family business legacy; and the desire to portray a positive family business image. While plans for succession and business strategy are important, successful family businesses are able to survive only if there is continuity in the family’s vision and mission for the business. Successful family businesses “not only have to perpetuate a strong business over a long period of time, but have to keep the family strong and solid over a long period of time as well.
Written System of Governance and Conflict Management Studies indicate that 60% of failed family business successions arise from relationship issues. Two of the most prevalent and effective ways to deal with communication problems in long-lasting family businesses are the formation of an independent board of directors and having regular family meetings.
Family businesses that have independent boards tend to grow faster. Independent boards may be comprised of family members, key non-family employees and non-family directors with no vested capital interest in the company. This type of independent board allows directors (both family and non-family) to meet and discuss important business aspects for the future of the business.
Similarly, regular family meetings allow family members to create processes, policies and share expectations for the family, as well as for the business. While some policies might be liberal (e.g., leeway with charitable and social causes) and others restrictive (e.g., limiting management positions for family members only to those with years of outside experience and an MBA or equivalent degree), regular family meetings allow families to work on policies, reach consensus and articulate rules by which to deal with conflicts within the family. This is also related to implementing a family code of shared values, which tends to minimize family conflicts because it provides a shared vision of business goals and implied rules concerning how to achieve those goals.