Background

   Family businesses the world over repeat the same succession cycle in every generation.  While businesses, personalities, social customs and tax codes vary, the same questions must be answered in every generation to ensure a successful intergenerational transition.

   These question revolve around six fundamental transitions which comprise the succession planning process. The following is a graphic we have developed to depict the six succession transitions.

   We consider the Founder and Family transitions "enabling" transitions because they impact the entire succession process. (Note that we use the term "Founder" for purposes of brevity. Substitute the term "Current Leader's Transition" in all generations after the first.)  The Business, Management, Ownership and Estate transitions are "implementation" transitions.  These four transitions get done well only with the support of the founder (or current leader) and the family. Accordingly, the succession process proceeds best when approached in almost linear order. The Founder's transition should be considered first, followed by the Family, Business, Management, Ownership, and Estate transitions.

Succession Challenges

1. All family businesses face three fundamental succession planning challenges:
2. While there are sound principles to be followed, there are no textbook answers that can be universally applied;
3. The answers that worked for the last generation may not be the right answers for the next generation; and
4. Finding the "success" in family business succession depends largely on knowing what questions need to be asked and answered.

The Doud Hausner & Associates Six Transition Model provides a framework for effective succession planning in family businesses.  The essential elements of each of the six transitions are summarized in the remainder of this paper.

The Founder's (Current Leader's) Transition

There are three great truths about the Founder's Transition:

1. If the founder is not prepared to make a graceful transition, the rest of the succession process will not proceed very effectively - if at all.
2. If the founder or current leader stays in control long enough, his/her "firm grip" on the business will become a "stranglehold."
3. As a founder or current leader, you can elect to "die in the saddle," but remember that if you do it will be very hard on the horse.

The essential elements of a good Founder's Transition are:

1. Having a clear sense of personal direction for the future
2. Becoming a good teacher, mentor and door opener
3. Having financial resources independent of the operating results of the business.

Personal Direction

   Most family business leaders have devoted such a disproportionate amount of their time and energies to the business that they have few (if any) interests outside the business.  Developing a personal vision and "growth" plan that moves one's interests and activities beyond the boundaries of the business is a vital first step in this transition. It helps for one to truly believe that there is, indeed, life beyond the business.

   At the same time, the founder's personal vision and growth plan should leave room for continued and appropriate business involvement. It need not be an "all or nothing" proposition.  When founders move too far from the business at too rapid a pace the business loses the advantages of their business knowledge and contacts with key customers, suppliers, the industry and even competitors.  The most effective Founder's Transitions include ways for the business to have continued access to these important assets.

Roles

   The founder has both an opportunity and a responsibility to play three vital roles during the latter stages of his/her active business life:

1. As a Teacher, founders should be actively and purposefully transferring vital knowledge to their successor(s).
2. As a Mentor, founders should be serving as a guide and sounding board as successors apply their skills and knowledge.
3. As a Door Opener, founders should be planfully transferring key contacts and relationships to provide continuity.

Financial Independence

   Far too many founders have put so many of their eggs into the family business basket that they must rely on the revenues and profits of the business to fund their retirement income. There are two basic problems with this approach:

1. Supporting a less than fully active executive at full pay can be a heavy financial burden for the business.
2. It leaves the founder and his/her spouse dependent on the operating fortunes of a business they no longer control.

   In 30 years of consulting with family businesses we have yet to meet a founder or current leader who trusts his/her successors that much.  So the reality is that if the founders income security in retirement is dependent on business operations he/she will never let go.

The Family Transition

   The basic challenge of the Family Transition involves successfully overcoming the following dilemma (1) Because the succession process touches everyone in the family, the adults need to be able to participate in deliberation and decision making. This means having the ability and willingness to openly confront issues which may have a high emotional content. (2) However, in virtually all cultures, open confrontation is something families avoid. And dealing with emotions is something for which most family members (and, particularly, most male family members) are ill equipped.

   Universally, we find that everyone involved in a family business is seeking to attain three important goals:

1. Business prosperity
2. Family harmony
3. Personal well-being.

   The difficulty most often encountered in simultaneously achieving business prosperity and family harmony is that the values which drive objective business decisions are directly opposed to the values which drive emotional family decisions. The problem with achieving personal well-being in a family business setting is that each person's definition of personal well-being will differ somewhat from everyone else's definition.

   Accordingly, our work in the Family Transition involves:

1. Identifying those issues which are getting in the way of business prosperity and family harmony, and understanding the similarities and differences in each family member's definition of personal well-being.
2. Working with the family's built-in resistance to confrontation, and teaching family members the skills and techniques of effective communication, conflict resolution and problem solving.
3. Facilitating business meetings and family retreats at which those skills can be applied to addressing the questions which arise during the succession planning process.

The Business Transition

   Two critical elements of the business transition are (1) optimizing operating efficiency; and (2) developing a sense of strategic direction.

     Operating Efficiency

   Most family businesses behave, to some degree, as if they were following the time-honored maxim "Common sense is not an acceptable substitute for tradition." In other words, most family businesses adhere to certain business practices, product lines, etc. because they have always done it that way. Additionally, if the family has not identified and/or effectively resolved differences between business-based and family-based decision making, there are typically family/business relationship issues about which the family is in conflict. Without exception, if the family is in conflict the business will be negatively affected.

   Much of our work in the Business Transition aspect of succession planning involves strengthening management teams and helping operating management identify and solve those 20% of the operating problems that account for 80% of the negative impact of operating efficiency. Doing this requires, in part, that the family be able to define the rules by which it will manage the family/business relationship.  Therefore, the communication and problem solving skills which are built as part of the Family Transition must be in place before the Business Transition can be effectively addressed.

    Strategic Vision

   Yogi Berra, the great American baseball player and "philosopher" said "If you don't know where you're going, you're liable to end up someplace else."  Few middle market businesses adopt the discipline of participative, systematic strategic thinking.  As a result, whatever vision guides those businesses is often bottled up inside the founder's or current leader's mind.

   Nothing is forever.  Business conditions change. As we will establish later in this paper, making good decisions about the Management and Ownership Transitions depends on knowing where the business is headed over the longer term - and how bright its strategic future appears. Accordingly, working with operating management, boards of directors, boards of advisors and owners to craft a strategic vision and a plan for attaining that vision is a second major focus of our work in the Business Transition.

   Engaging the Business Transition will help you develop an understanding of:

1. What resources will be needed to make the business operationally effective.
2. How attractive a strategic future the business has, and what resources will be needed to secure that future.
3. Whether you have access to necessary operational and strategic resources at an affordable cost and within a reasonable time frame.
4. The level of risk owners will have to incur in the near term and longer term.
5. What benefits the owners can anticipate in return for assuming continuing business risk.

   This information provides important dimension to the family's decision about whether to transfer ownership into the next generation.

The Management Transition

   The Management Transition provides the other major basis for a decision about the future of ownership. Critical questions to be addressed in this transition include:

1. What will the management model be in the next generation?
2. Do the family members interested in managing the business in the next generation have the needed competencies or the potential to develop them?
3. Are there viable options to family management?

The Management Model

   The management model will change in the next generation. The only question is will it be a planned change or will it simply be allowed to evolve.  We strongly recommend the former.  The changes in the management model usually require that families recognize the following generational differences:

1. First generation business going to the second encounter the evolution from a single, all-powerful owner/executive to a sibling partnership in which power and authority must be shared.
2. For second generation businesses going into the third, the change is usually from a sibling partnership to a confederation of cousins.  Typically we find that cousins have not grown up with connections as close as siblings. They come from different family branches with different value systems. They must be molded into an effective management team
3. When businesses move beyond the third generation the issue is typically the growing number of family members.  How will the family ensure appropriate representation of numerous branches when the business may not have room for employees from every branch?

Competency and Potential

   What is needed is an objective assessment of the competency and potential of family candidates for top management positions.  It is a tall order. Without the communication and problem solving abilities developed in the Family Transition, it is unlikely that a family will be able to make a realistic assessment.  Without the knowledge gained in the Business Transition, it is equally unlikely that a family will know what management skills are needed.  These are the two biggest stumbling blocks to this element of the Management Transition.

Viable Alternatives

   Is the family willing to look beyond itself for business leadership when necessary?  Suppose the next generation has potential but the timing is off.

Imagine a situation in which the next generation shows promise and is developing, but cannot yet provide the management and leadership skills needed in the business.  The family's willingness to consider non family business leadership (interim or permanent) will depend in part upon the family's philosophy and in part upon the characteristics of the business itself.

   As a family works through the Management Transition issues it will gain part of the needed perspective on whether continued family management in the next generation is a viable objective.

The Ownership Transition

   As a result of work on the Business and Management Transitions, the owners should understand the short- and longer-term business risks, the anticipated ownership rewards and the viability of an effective management transition. This is information the family needs to make the decisions inherent in the Ownership Transition.  If the interpretation of that information leads the family to favor continued ownership, then the Ownership Transition will involve determining (1)  who should have ownership; (2) how to transfer it to the future owners in a way that is tax effective and respects the needs of the business; and (3) building a responsible ownership team.

Who Should Have Ownership

   When working with clients who are contemplating the transfer of business ownership within the family, the best general advice we can give is that in matters of ownership, fair is usually not equal - and equal is rarely fair.

   Consider the real possibility that business ownership may not be a very attractive investment for all family members - particularly for those who are not active in the business.  It is important for potential owners to know whether the share of the business they may own will be a growth investment or an income producing investment.  Inactive owners who are not drawing salaries and benefits from the business often find income producing investment much more attractive than growth investment.  The reality is that the majority of family business do not regularly pay meaningful dividends.  Giving a growth investment to an owner who wants income is a blueprint for later conflict and disaffection.

   Most families start the succession planning process assuming they will make a transition to the next generation of family ownership. However, the work done in the Business and Management Transitions may lead to a decision to divest business ownership. If so, ownership transfer planning will go in the direction of a strategic alliance, merger or sale to non family interests.  Even if that is the case, the succession planning work done to this point is not wasted. A well managed and profitable business with a clear strategic direction and strong management team will command greater value for the owners.

How To Transfer Ownership

   We are not tax experts.  So when it comes to helping our clients implement the decisions made in the Ownership Transition we routinely work with attorneys and accountants who have that technical expertise. Whatever a family's decision about who gets what relative to the business, be guided by the following principles:

1. The sooner you make the ownership transfer decision, the more flexibility you have.
2. The sooner you actually transfer ownership, the more tax effective you can be.
3. The ownership transfer plan should be as tax effective as possible without being tax driven.  Keep the needs of the business and the family in mind.  We have seen situations in which a tax driven plan has hurt the business, the family, or both.

Building The Ownership Team

   Make sure that all owners:

1. Know the limits of the rights, responsibilities and decision authority that accompany ownership. (Owners, for example, should not have a voice in management decisions simply by virtue of the fact they hold stock in the family business).
2. Have the information needed to make responsible ownership decisions.
3. Have the training and skills to understand and interpret the ownership information they receive.  (For example, far too many family business owners regularly receive financial statements but are unable to understand or interpret them).

The Estate Transition

   Although they are closely connected, we have separated the Ownership and Estate Transitions for planning purposes. The rationale for separating these two transitions is as follows:

1. Ownership transfer decisions should contain a heavy dose of business thinking.  Remember, when it comes to dividing business ownership among family members, equal may seem easy, but it is rarely fair.
2. Conversely, estate transfer decisions typically emphasize the family value of equality.  Most parents want to divide their total estate equally among their children.
3. Given the differences in emphasis between ownership transfer and estate transfer decisions, the Estate Transition is done best once the Ownership Transition decisions have been made.

     Planning Principles

   The two planning principles which should be used to guide thinking about and planning for the Estate Transition are:

1. First make ownership transfer decisions which ensure fairness and business continuity.
2. Only then can you make estate transfer decisions which (if you wish) can provide for equality.

     Legacy

   The ideal legacy the current generation of leaders and owners can leave their family businesses is to provide options so that (1)  those family members who want to continue the business legacy have an opportunity to do so; and (2) those family members who are better served in other ways have that option.  With careful and timely planning in most situations you can have it both ways.

   Again, we defer to the estate planning and tax professionals for specific implementation advice about which of the many estate transfer vehicles should be used for a specific client.  However, one of the previously mentioned principles of ownership transfer applies to estate transfer decisions The sooner you make your estate transfer decisions, the more flexibility you have.

In Conclusion

   Achieving all three family business goals (Business prosperity, Family harmony, Personal well-being) requires balancing family, business and personal needs. The Doud Hausner & Associates Six Transition model provides a framework within which a family can work to reach and maintain that balance. The qualities required to succeed are:

1. Vision Knowing what the family stands for
2. Values Knowing what the family stands on
3. Voice Having and using the ability to communicate effectively
4. Vehicles Designing the mechanisms by which to implement decisions
5. Viability Knowing whether the required financial, management and personal resources are available now or able to be developed when needed.
6. Volition If "Commitment," and "Guts" each started with a "V," we would have used those two words instead.