Family Business
Advisor & Coach

Family Business Succession: A two-headed creature

Secession of the senior generation and succession of the next generation are currently front burner issues for many of our family businesses (FB).  The demographics bear this out as the prolific baby boomer generation prepares to retire over the next few years. This is a time of shifting leadership and is traditionally one of the most vulnerable periods in family businesses. Research reveals that many FBs fail to make it over that hump of changing of the generations.

Two Kinds of Succession

There is a dichotomy to succession in a family business.  There is the question of management or leadership succession; and there is the issue of ownership succession. Often FBs fail to make the distinction and this may well complicate both transitions. Management succession is a matter of determining the best person to lead the business for the future.  This requires an assessment of the needs of the business going forward; identifying the skills needed for the leadership role and finally spotting and grooming that person or persons.  These simple phrases belie the difficulties involved and are not meant to minimize the challenges inherent in succession for both family and non-family businesses.

This article, though, will focus on ownership succession, a conundrum that keeps my senior generation clients awake at night.  How, to whom and when to distribute those shares?  These are questions that arise after the owning family has already decided to maintain the business as a fully family-owned entity.  There are other options available and some families opt to sell the business or go public.  There are still decisions to be made about dividing the proceeds, and somehow, those decisions do not seem as daunting as the ones concerning distribution of shares.

Two Classes of Shareholders

The distinction between the two groups of family shareholders is not a legal separation, although a business owner may well decide to implement legal differentiations.  The division is one between family members who work in the business and those who do not. The FB literature labels the former as active shareholders and the latter as passive shareholders. The very terminology may set up an expectation of conflict, as it could suggest that those family members who do not work in the business do not contribute to the success of the business.

If indeed this is the case for some FBs, then it is a failing of the family business system, not evidence of any naturally occurring line of separation between the two groups. Senior generation members may unwittingly set up a division by signalling, subtly or not, that those family members who choose not to work the business are second class citizens.  Parents may feel constrained to bestow shares on those children, even if they view their ownership as purely financial and legal.  The input of passive shareholders is often not solicited and if given, it is hardly considered.

I have also encountered parents who may have acquired investments outside of the operational business and think that the best path forward is to leave the business only to active shareholders and give property and other investments to passive shareholders.  Their intent is honourable and they are seeking to reduce financial differences between the two groups, with the hope of reducing conflict. They run the risk, however, of alienating those who do not inherit the business.  First off, it is almost impossible to determine the future value of operational businesses versus real estate or shares, so any guise of equality is really an illusion.

Secondly, those who do not own shares in the business may feel slighted, as they see the business as their parents’ s legacy and view their non-inclusion in the business as indication of their worth to their parents. Often, gender issues come to the fore if all the sons have entered the business and the daughters have not.

Ownership transfer in a family business is not just about legal and financial power, it is also an emotional process. Passive shareholders can display psychological ownership of the business and can play a valuable role in promoting the family business in any number of ways. On the business side, I have seen passive shareholders bring entrepreneurial ideas to the business, and on the family side, they often play the role of mediator among active shareholders.  Shared ownership between the two groups is a viable option, provided that there is a common ownership vision among all family members, as well as good governance mechanisms to promote transparency and open communication, and a fair buy-sell provision, among other professional FB protocols.

Many family business owners fear that this is too much of a stretch and they cannot foresee what contribution their daughter, the gynaecologist, could possibly bring to a food distribution business.   Plus, they must contend with the active shareholders who clamour that they are doing all the work and have to share the rewards with passive shareholders. Those who work in the business are often accused of “not knowing anything about the business and only caring about dividends.”  Yet, owners want to recognize all of their children and are particularly hard pressed when practically all of the family’s wealth has accrued in the business.  For many senior generation owners, theirs is a dilemma that could initiate insomnia.