Successful handover in family businesses

The five most common stumbling blocks for a successful handover in family businesses

Why cross-generational continuity in the family business is not a given

Family businesses have once again proven their worth in the corona crisis. With their entrepreneurship and sustainable business practices, they were able to respond more flexibly to the crisis than many large corporations. However, the pandemic also shows that structural changes are needed in family businesses. But regardless of how they position themselves in the future, the regulation of business succession remains a bottleneck for the secure continuation of every family business. The reasons for this are complex. By Carola Jungwirth

IF THE SENIOR GENERATION RELINQUISHES INFLUENCE IN THE COMPANY AGAINST ITS WILL BUT CONTINUES TO RETAIN POWER IN THE COMPANY, IT UNDERMINES THE AUTHORITY OF THE SUCCESSOR GENERATION.

Family businesses traditionally form the backbone of the economy, e.g. 89% of companies in Germany are family-run. In the USA, family businesses contribute around 54% of private sector GDP and are responsible for employing 59% of private sector workforce. The Institut für Mittelstand (a German institute for small and medium-sized businesses) assumes that half of all family businesses aim for internal succession. However, statistics show that only seven out of ten family businesses succeed in transferring to the second generation. Only two of the ten family businesses still exist in the third generation. And finally, only one family business in the fourth generation is still managed by the founding family at the operational or ownership level. What exactly makes the cross-generational continuation of family businesses more difficult? Even though every family business is unique and every succession is individual, typical pitfalls that complicate the succession process emerge especially during the generational transition. The five most common are presented in this article. TRAP #1: FAMILY CONCERNS VS. BUSINESS CONCERNS

The greatest challenge for family businesses is the interplay between family and business concerns. Unlike a business, a family is not designed for success, but for love and harmony. Both systems – if family and business are considered as two systems here – pursue different interests. Family businesses are particularly affected by these conflicting interests. The reason for this can already be seen in the name: in a family business there is always family and business. These two systems are blended when they interact. Ideally, both sets of interests should be taken into account when making business decisions in a family business. However, this is not always possible. Operationally, it becomes difficult when greater importance is attached to family peace than to professional aspects in important business decisions. Here is a case study: An entrepreneurial couple has two children and would like to start the family-internal generation change in the company. Both children have signaled their general willingness to take

With each generation, the number of shareholders in a family business grows, and sometimes so does the number of intra-family conflicts.

on the succession. One of the children is objectively more suitable for succession because of their education. If the two children were external applicants, the couple would have an easy time choosing – they would let the objective criteria speak for themselves. As parents, however, they want to treat their offspring equally, and so they decide to appoint a joint leadership team of both siblings as the new management. From a family perspective, it is understandable that parents want to treat their children equally. Equal treatment contributes to peace within the family. From a corporate perspective, this approach can cause problems. In the example case, the dual leadership, which was chosen for family reasons, could jeopardize the company's ability to act. If the two managing directors cannot agree, a stalemate situation may arise. This can also happen in the case of a non-sibling dual leadership. In the latter case, however, it is less likely that emotional arguments will lead to the stalemate.

TRAP #2: LACK OF ROLE SEPARATION BETWEEN FAMILY AND COMPANY

A real-life example is also useful for this stumbling block: Advisory board meeting in the medium-sized family business. In addition to the three external advisory board members, the company founder and his successor daughter are present. Both are active in the company as managing directors. Future investments are to be discussed. In the middle of the discussion, the company founder takes off his spectacles, looks at the lenses and pushes the spectacles over to his daughter sitting next to him with the remark: “Could you clean them?”

WHAT HAPPENED?

The founder of the company did not communicate with his co-manager as the senior boss. Instead, it was the father who spoke to his daughter. It's hard to imagine that two unrelated managing directors would speak to each other in this tone, even more so in front of third parties. Keeping roles separate is a daily challenge that only arises in family businesses. At Sunday coffee, the two protagonists still sit together as father and daughter. But as soon as they enter the company, their roles change. They have to put on a different „hat” in order to be able to meet as joint managing directors at eye level. This constant change of roles is difficult in many family businesses. It quickly comes across as artificial and wooden when trying to maintain a certain form and professionalism in the company with the person you meet on Sundays in the family circle. Why does this role dilemma pose a threat to the success of corporate succession? When two generations of a company converse in a “parent-child” relationship, the authority of the successor generation is limited in its outward appearance. This applies above all to the perception of employees, who have a sixth sense for “true authority” in the company.

TRAP #3: MISSING THE RIGHT MOMENT FOR THE TRANSFER

In some cases, senior entrepreneurs are still active in the company at the ripe old age of 75, whether operationally or at shareholder level. For them, succession is primarily a process of letting go personally. That takes time. They probably spent most of their working lives in the company, so that it became their main purpose in life. Many long-time entrepreneurs remain in the company because they don't have a “plan B” for what their lives might look like without the family business. This constellation can have a negative impact on the success of the company successor. If the previous management leaves the company only at an advanced age, the family successor may also already have passed the age of 50. For the next generation of executives, the long wait to take over the company

means a loss of energy and authority, and it blocks new entrepreneurial impulses. There is no objectively right time for company succession. According to the so-called rating criteria of the banks, the succession should be clarified by the 55th year of life of the company owners, i.e. there should be an appropriate plan. The handover process can easily take up to five years. This should be taken into account when planning the timeframe. If the succession cannot be arranged within the family, an external solution is an alternative. This is also a personal matter for the senior generation, which takes time and needs to be well planned. Succession planning under time pressure increases the risk of not achieving the best solution for those involved and the company.

TRAP #4: FINANCIAL STUMBLING BLOCKS

Regardless of whether the company succession is to be handled internally or externally – the financial aspects of a succession can be a stumbling block for all variants. If the company is to be sold to an external successor, the purchase price expectations of the buyer and seller often diverge. It tends to be the owner/ seller who makes succession planning more difficult with unrealistic price expectations. Emotional aspects also play a role in this. As a rule, the owner is not just selling a company, but his life's work, in which he has invested energy, time and money for decades. Many entrepreneurs find it difficult to reduce their life's work to sober numbers. Unfortunately, life's work is not an assessment criterion when determining the value of a company. In the case of internal succession, the main factor to consider is the tax burden involved in the transfer. If the company shares are to be transferred to the next generation free of charge, gift or inheritance tax will be incurred. If no reserves have been set aside for this purpose, the company may get into difficulties due to a lack of liquidity. After all, the tax office does not wait long to be paid for the transaction and, in case of doubt, the next generation is not in a position to pay the tax amounts from its private capital.

TRAP #5: TAX OPTIMIZATION AS A TRAP FOR BUSINESS SUCCESSION

The success of an internal succession can also be jeopardized if the company shares are transferred to the next generation solely for tax-saving reasons. Tax advisors often suggest transferring the company shares to the children at an early stage in order to take advantage of gift tax allowances. However, if tax reasons are the sole reason for a generational change, the central question remains unanswered as to whether the current management is at all ready to take a step back in the company and relinquish power. If this is not the case, the senior management may keep (legal) loopholes open in order to continue to exert influence within the company. This can be done, for example, by reserving retransfer rights. If the senior generation relinquishes influence against its will but continues to retain some power in the company, it undermines the authority of the successor generation. This weakens the new management because there are no clear decision-making structures.

HOW CAN THESE PITFALLS BE OVERCOME?

A company succession is only successful if the family business is led safely into the future while preserving family peace. The complexity of succession issues and the interplay between family and business aspects can best be resolved with professional support. After all, corporate succession is an individual and personal process that must be tailored to the needs of those involved if it is to succeed. Two concrete measures are a good start to maneuver the flagship “family business” through the choppy sea of business succession:

Keeping the reins in your hands through timely planning

A succession process is lengthy and extensive. In addition to numerous legal, tax and financial issues, there are personal issues to be addressed. To manage the complexity of this process, three to five years should be scheduled for the implementation of the succession and an individual succession strategy should be created with professional help.

Avoid disputes through counseling

During the succession process, conflicts may arise between family members. The more conflicts arise, the more important it is for the success of the succession to get disputes out of the way in good time, if necessary with outside support. Even legal or tax issues can pose a risk to a successful generational change. In addition, there may be conflicts within the family, the resolution of which is indispensable for securing family peace AND the future of the company. In any case, the realization remains: those who are aware of the typical pitfalls in succession at an early stage take their force away and are also able to counter them proactively.

Carola Jungwirth

Succession consultant Carola Jungwirth advises family businesses and accompanies entrepreneurial families during their internal succession. As a lawyer and coach, she has extensive expertise in her work. Carola Jungwirth herself comes from an entrepreneurial family, worked for almost ten years as a legal advisor in a large construction group, and then managed her own family business as a managing partner in the 3rd generation. Since 2015, she has been working exclusively as a succession consultant. www.jungwirth-nachfolgeberatung.de