Transferring Control in a Family Business

Chris Hunter

9 years ago

The family business is an important part of any national economy. In the U.S. something like 90% of all businesses are either owned or controlled by a family. It’s about the same in Canada, the U.K., Australia and New Zealand. And they aren’t all small businesses either; about one third of Fortune 500 firms in the U.S. are family-owned. Family businesses have an unfortunate weak spot that means only one out of three survives the transition from the first generation of ownership to the second. Only one out of two survive the transition from second to third generation ownership.

This poor survival rate is generally felt to be the result of poor planning for the future rather than resulting from the more visible family disputes that often make the newspapers. It’s estimated that 40% of family-owned businesses are facing a transfer of ownership or control issue at any given time. The issue can arise due to the death or incapacity of a family member or it could be the result of new family members being brought into the management of the business.

For the founder of a family business there are few options when it comes to giving up control:

1. Stop trading and close the doors
2. Sell to someone outside the family
3. Retain family ownership but hire outside management
4. Retain family ownership and management

Since statistics show that the survival rate of businesses choosing options 3 and 4 is so low, it follows that more attention needs to be given to the issue before the need to transfer ownership arises. Why is the survival rate so low? Experts in family business management say that four basic factors are the cause. They can occur independently of each other or they can be linked together, and the result is likely to spell disaster for the enterprise.

The first and most common cause of failure is a lack of planning. The business reaches a point of crisis and no plan is in place to facilitate the transfer of ownership from on family member to another. The resulting disruption causes the eventual demise of the organization.

Another statistically important factor is that the business lacks viability. This most often happens when the founder’s personality or abilities lay at the heart of the business and can’t be replicated by later generations.

In some cases of failure the owner has little interest in handing the firm over to the next generation and just accepts that when he or she depart the business will end. A fourth cause of failure is simply that no one else in the family wants to take it over.

Even if these last two factors apply, it makes sense for the owner of any family business to optimize their return from the enterprise by making plans for a smooth transfer of ownership when it becomes necessary. When the right kind of planning has been done the business will usually survive the transfer and remain viable.

There are four distinct plans that need to be done. Each is a complete and separate plan that complements the others, and all four plans need to be prepared to ensure the organization’s survival.

A Strategic Long-term Plan for the Business

A strategic plan for the business charts a course for the firm and details the goals of the business. Is growth of the enterprise the goal or is it there to provide an income for family members? Will the business trade aggressively or conservatively? Working through these kinds of details creates a clear picture of the intended future of the business.

A Plan for Each Family Member

This plan addresses issues of importance to all members of the family. It outlines the role of the family in the business and the part each family member will play. It can state policies regarding employment of family members, how they might leave the business and what their entitlements are, and what support family members will receive from the business to ensure they are adequately trained and qualified to take a part in the firm.

A Business Succession Plan

The succession plan states who will take over when the present owner leaves the position and when the transition will take place. It tells what the role of the former owner will be and what compensation they will receive. It includes a timetable for the handing over of executive power and what remuneration the family member who takes over will receive. If desired a succession plan can include other family members in board or management positions as part of the succession arrangements.

Estate Planning

Many family businesses fail because the owner dies and hasn’t reflected the business succession or transition arrangements in their estate planning. The business is an asset like any other asset and can be subjected to destructive taxation if the estate planning isn’t done correctly.

Preparing four separate plans to handle the transfer of control in a family business may seem like a lot of work, and if done correctly it will be. But the alternative is for the enterprise to join the numbers of failures and either fade away or self-destruct.