For families in business nothing is more challenging than succession. Part of the problem is that succession is a multi-disciplinary task, involves multiple stakeholders, and is a once-in-a-lifetime challenge for most entrepreneurs. So, where to start when dealing with succession? Here is an attempt towards filling this gap – a six step process for practitioners to consider when developing a succession plan for a small to mid-sized firm.
- Clarifying the goals and priorities
Both incumbent and successor have to clarify their goals and priorities with regard to succession. For the incumbent it is paramount to prioritize the succession options he or she faces and to develop a time plan along which to pursue them. For the successor it is important to clarify his or her commitment and abilities to take over the firm.
- Reviewing the firm’s strategy
Many small to mid-sized firms face strategic challenges at the moment they should be passed on, e.g., dependence of the firm on the current entrepreneur, stagnating performance, or intertwined operating and non-operating assets. To make the firm an attractive target to be taken over, the firm has to be made strategically ready, e.g., by establishing an effective leadership team supporting the entrepreneur, the rejuvenation of the product portfolio, and the separation of operating from non-operating assets.
- Planning the transition of responsibilities
When the firm is sold to a strategic or financial investor, ownership, board, and management responsibilities are passed on quite rapidly, sometimes within days. But when children or employees are the new owners, the incumbent entrepreneur typically retains some influence over time, so that ownership, board, and management responsibilities are passed on gradually. To avoid misunderstandings along this process, both parties should agree on a governance roadmap that specifies the timeline when the various responsibilities are passed on from the incumbent to the new entrepreneur.
- Valuing the firm
Inheritance tax regulations, especially in common law countries, set firm valuation standards which cannot be departed from. In practice, however, incumbent and successor typically have some leeway in setting the transfer price for the company shares. The transfer price therefore, not only reflects the financial value of the firm but also the social relationship between incumbent and successor: the closer the ties, in particular in a transfer from parents to children, the more generous the incumbent with regard to the transfer price.
- Financing the succession
While a financial or strategic buyer will be able to compensate the incumbent with a cash payment, in a transfer to children, parents often have to co-finance the deal, for instance via a vendor loan. Typically, succession in the context of small to mid-sized firms are financed by owner’s equity of the new owner, a vendor loan, and/or a bank loan. Just as in valuation, the relationship between incumbent and successor will influence the concessions the incumbent is willing to make regarding financing.
- Defining the tax and legal setup
There are important international, and sometimes even within country, variations with regard to the legal and tax implications of a family business succession. Not only do we distinguish between share and asset deals, but there is significant variation in the available tools to legally structure family business successions, such as trusts in the US or holding companies in continental Europe. The choice of the appropriate legal structure, however, is not the starting point but the consequence of our answers to the previous five questions.
In sum, the process outlined is an attempt to deal with the complexity of family business succession in the small to mid-sized firm context. It is not a one size fits all strategic concept, but an attempt towards structuring what may easily become a messy process.
About the contributor
Thomas Zellweger is a professor of management at the University of St. Gallen, Switzerland. In his research he deals with the governance, strategic management and long-term success of family firms. He has won the FFI best unpublished paper award twice. He is the author of the recently published international text book: Managing the Family Business. In his book he further outlines the succession process described above, and also discusses the relevance of family firms across the globe, their unique strengths and weaknesses, their governance, strategic management, drivers of long-term success and interpersonal dynamics. He can be reached at firstname.lastname@example.org.