It is sometimes implied that the next generation will take over the family business. The children have been trained since birth to do so.
But is this always a good idea? What does science tell us and what is an alternative approach?
Transitions from one generation to the next are a highly individual process that does not go well with templated solutions, as sometimes offered by Private Banks interested in retaining the banking relationship with the family.
Academic writing has been somewhat split on this question. In the following, I will very briefly outline the factors needed to be in place for an “internal solution” of succession to work and what the usual factors are that make it fail. An alternative to finding a successor can sometimes be just letting the children do their own thing, instilled/enabled through an entrepreneurial attitude or mindset that has been carefully grafted over the years.
As this is a blog article aimed at the general public, I will refrain from referencing the relevant academic papers to keep the article readable; if you want to know more or receive a list of papers that would be interesting to read, please do reach out to me directly [LINK to my About page and LinkedIn profile].
Taking on the family business
Many families want their offspring to succeed.
More often than not it’s a “the apple does not fall far from the tree” kind of thinking (or wishing) that is severely upset when it does not work out as hoped.
In general, academic writing on this topic is somewhat split between what works and what does not work.
Factors that make a family business succeed with a family member as a successor
The proponents of a succession model argue that the family values are deeply enthused by the offspring, who can take over the family business and lead it further as if the incumbent had not left at all. This is then embodied in the “Stewardship”-model: the successors act as stewards of the wealth for future generations in perpetuity. This necessitates a couple of points, though:
- The successor is prepared, capable, and most competent of the available successors within and outside of the family and willing to take over;
- The incumbent is ready to bow out and let go;
- All the stakeholders (other family members, employees, management, suppliers, clients, etc.) agree to the change;
- Measures are in place to mitigate “Agency Issues”, the misappropriation of tangible or intangible benefits from the shareholders by the successor. Such measures can be either provided through laws and regulations (minority shareholder rights, etc.) or internal governance procedures; finally
- A powerful and competent oversight committee is in place to enforce all previous points, under a Stewardship-model of thinking.
If all these points are in place, then a handing over to the next generation can indeed be successful. Various successful handovers have been reported.
Factors that make a family business succession with family members doubtful
Despite this, and to highlight the complexity, only a very small minority of family-run firms survive to the third generation.
One of the issues to bring this question to a close is of course how do you measure success? Is success only given when a family firm stays in the family or can success also be defined as selling a majority shareholding and continuing as a “Portfoliopreneurial” family?
On the other side, we have – but we have to be aware of the survivorship bias as noted in the previous paragraph – numerous studies that show family businesses, especially in the second and subsequent generations and without the founder on the board of directors, severely underperforming other comparable companies.
The most common issues here are:
- Incompetent management by family members (or, put more diplomatically, there would have been better candidates for the job outside of the family);
- Misappropriation of funds and the inefficient allocation and use of capital for the sole benefit of family members. Examples include using company jets for private flights (which, by the way, also happens in public firms), financing pet projects that have only little commercial value to the family firm as such, or overly generous salary packages and employment of family members without corresponding work being done, etc.;
- Ineffective oversight by governing bodies;
- Lack of legal protection and regulatory oversight for both shareholders and, especially, minority shareholders; and
- A sense of misplaced duty to continue the family business despite the overall economic landscape changing to the contrary.
Within these different forces pulling a family in different directions, a path must be forged to start the succession process.
The Entrepreneurial Mindset as an alternative?
A recent strand of research papers highlights the importance of entrepreneurship. To practitioners, this may not come as a big surprise. The big step here – also for practitioners who don’t want to “wing it” and have a more methodologically sound approach – is how you define and foster entrepreneurship.
Some of the highlights on fostering entrepreneurship in the context of UHNWI’s are:
- Start with small entrepreneurial “games” when the children are young to develop the mindset of having to work and enter a (controlled) risk to gain something;
- Learn the concepts of risk and how to measure risk to avoid early-on missteps that put doubt into the mind of a young person;
- Have an active policy in place to foster, finance, and support entrepreneurial activities;
- Supporting entrepreneurial activities does not just mean financing, but (must) also include intangible support in form of playing devil’s advocate, helping with the business plan, and oversight/monitoring the same. As I have learned myself, the Entrepreneurial Life is a Lonely Life to some extent;
- Become Failure Resilient: [Link to the previous article on this topic] Not everything can be a success and sometimes I think that a founder’s success in the past could not be recreated today – hence we need a more lenient way to measure success and become failure resilient. What we gain out of this mindset is the ability to get up, brush off the dust and continue with another project; and finally
- Have a plan in place to outline and map the financial participation of the rest of the family in the success of one family member. This is especially important if the family provides both tangible (financial capital) and intangible (relationships, time, etc.) resources to the undertaking.
I have a slight suspicion that the most important factor for families is to instill an entrepreneurial attitude within the family.
Continuing a family business makes many things easier and it is often emotionally [link to emotional value article] difficult for a founder to let go of his “baby”, after spending a great deal of his life building it up. A nice thought is to see a child continuing the work started. In some cases, the family business will generate other benefits it cannot reap with external management – but if this is a real benefit to a family now only shows that the whole process will probably fail due to Agency issues, as described earlier on. Some cultural aspects need to be considered, of course. Next to this, we can also see a tendency for family businesses to stay within a family if the country’s legal framework does not provide for sufficient protection for the shareholders, and thus a family is forced to keep on managing the company.
But I also think that at dark moments doubts about this approach do come up.
Perhaps a more rational approach is to leave the continuation of the management of the family business by a family member as an optionality.
A family business can be still kept within the family’s ownership but with external management while the children undertake their entrepreneurial journey.
If there is little interest in the family to continue, it also needs to be accepted by a founder. Nothing is lost, as such. It’s just going to continue in another way.
Bottom line is that a family needs to make a plan and involve all the stakeholders to ensure that everybody is on board. This plan cannot be made early enough. Each time the plan is reviewed in a regular review process it needs to be refined and adapted to the current situation and outlook.
If an open mind to the succession process is not attempted or cannot be achieved and the insistence on a family member taking on the family business prevails, I fear that the family will end up with the unfortunate outcome that befalls most wealthy families: From shirtsleeves to shirtsleeves within three generations.
The question of whether it is better for the next generation to take over the family business or to start something new is a complex one. The decision to transition from one generation to the next is a highly individual process and there is no one-size-fits-all solution.
Proponents of a succession model argue that family values are deeply ingrained in the offspring, who can take over the family business and lead it further as if the incumbent had not left at all. This is embodied in the “Stewardship” model, where the successors act as stewards of the wealth for future generations. However, for this model to be successful, several factors must be in place, including that the successor is prepared, capable, and most competent of the available successors within and outside of the family and willing to take over, the incumbent is ready to bow out and let go, all stakeholders agree to the change, measures are in place to mitigate “Agency Issues,” and a powerful and competent oversight committee is in place to enforce all previous points under a Stewardship model of thinking.
Despite this, only a very small minority of family-run firms survive to the third generation. One of the issues is how success is defined. Is success only given when a family firm stays in the family, or can success also be defined as selling a majority shareholding and continuing as a “Portfolio Entrepreneurial” family? Studies have also shown that family businesses, especially in the second and subsequent generations and without the founder on the board of directors, can severely underperform other comparable companies. The most common issues include incompetent management by family members, misappropriation of funds, and the inefficient allocation and use of capital for the sole benefit of family members.
An alternative approach to finding a successor is to instill an entrepreneurial attitude or mindset in the children and let them start something new. This can bring new perspectives, fresh ideas, and diverse opportunities to the family. However, it is important to remember that the decision of whether to take on the family business or start something new is highly individual, and there is no one right answer.