MAY/JUNE 2015


Guin ADVISERS FORUM

Preparing to transition your business to a leader from outside the family

By David Guin, Mark Haranzo and Sarah Pickering

Many of the obstacles that families face in passing their business to the next generation relate to the inextricable connection between "hard" and "soft" issues. The key to navigating these issues is flexibility.

Rather than "keeping everything in the family,"an increasing number of families are transitioning from managers to owners of their company as a part of a successful succession plan. Ownership, however, entails unique responsibilities and a different skill set than the one used in managing a business.

Identifying non-family members who can step into the management role presents multiple opportunities for growth and expansion, although selecting such individuals and finding ways to work together can also be a learning process. Looking back on our experiences working with families that have successfully undergone the shift from management to ownership, we have used their stories to develop the following guide to planning for the future.

The succession plan

A 2014 global study of family businesses by PricewaterhouseCoopers (PwC) reveals that only 16% of those surveyed have a documented succession plan for senior roles. Although this percentage is low, it is not altogether surprising. Generational transitions, like many other decisions in a family business, can be fraught with emotion. Often, senior family members avoid discussing who will take over the business when they retire, or they have a theoretical plan but refuse to turn over control in practice. Both these scenarios lead to uncertainty, which in turn increases the chance that a conflict will occur. Having a clear succession plan in place for the senior company roles reduces the likelihood of conflict and helps ensure a smooth transition to the next generation.

Even when family businesses have a succession plan, it may address only the transfer of management, without considering other governance structures that may be in place. A family with a robust governance plan often has additional structures—such as a family office, family council, family elector company or private trust company—that helps preserve family values within the corporate structure. While many families understand that a good succession plan provides for the election of new directors on the company's board, families should also plan for the election of successor trustees and partnership managers where necessary. In addition to holding a shareholders' meeting, consider also convening a family council meeting to discuss transition. If a formal family council has not yet been created, an upcoming transition presents an opportune time to establish one.

Ultimately, whatever succession plan you adopt should address existing non-business documents, such as trusts, life insurance and other estate planning and wealth-transfer arrangements, as well as the skills and expectations of other family members. While younger generations may be the first to recognize opportunities for streamlining or expansion, they may not be seasoned enough or lack sufficient management experience to confidently take over control of the company. As more and more families are having children later in life, this has become a very common scenario. In response, many families have implemented a two-fold approach: (1) finding a meaningful way to collect younger family members' input while encouraging their continued education and development; and (2) placing non-family members in a management role.

Using family governance to transition from management to ownership

Family governance represents a process for making decisions on all manner of family and business issues, using family values as the foundation for such decisions. A comprehensive family governance structure can address younger family members' suggestions and keep the younger generation involved without prematurely placing the business in their hands.

Like a succession plan, a family governance structure is useful only to the extent that it is written down. Most families have strong beliefs about how their company should be run, but in order for those values to become tools capable of supporting the business, they should be put to paper. Such written governance structures can take a variety of forms, but for convenience, we refer to them generally as a family constitution. A family constitution applies core family values to a myriad of corporate concepts, including dispute resolution, investment and distribution policies and a framework for the promotion of younger members to more senior roles.

The widening age gap between senior family business leaders and their offspring has had a pronounced impact on certain provisions in the family constitution. Increasingly, families are requiring managers to have external experience in addition to formal business education. As a corollary, constitutions have also begun to focus more on future ownership, rather than management, of the company.

The interrelationship between "hard" issues, like earnings and growth, and "soft"issues, such as values and relationships, in the typical family business is in some ways the company's greatest asset—and, potentially, also its greatest liability. Having strong core values can create a remarkable industry reputation. However, the specter of intrafamily conflict may make the business less appealing to investors and thus may diminish its value in a sale context. Transitioning family members from managers to owners can address these concerns. A good owner has a responsibility to the business, but it will take a different form than a manager's accountability. While numbers may be used in evaluating a manager's performance, assessing an owner's strength involves more qualitative criteria: How well does he understand the company? How well does she communicate expectations and goals?

Additionally, in closely held corporations, majority shareholders may owe a fiduciary duty to minority owners as well as to the company. Much more so than a manager, an owner should be conscious of all the different participants in the corporate community that surrounds a family business.

Professionalizing the family business is a process rather than a one-time event. Like other processes, it becomes easier the more it is practiced. Independent board members can provide families with a more objective view of their business model and can suggest areas for improvement.

Challenges of non-family management

Bringing in non-family executives—and independent board members—can have benefits, not just in terms of enhancing the company's current profitability, but also by ensuring the firm is well positioned for the future. By recruiting outside the family, a business can add specialized skill sets that enhance its capabilities. For example, the PwC survey found a strong trend toward exportation among family businesses, reflecting the realities of today's global economy. According to the survey, 68% of family businesses are exporting, and 75% expect to be doing so in the next five years. Some families, however, would face substantial challenges expanding into new markets or product lines. A manager from outside the family who is experienced in this area can help a family firm by providing contacts in untapped markets.

Recruiting individuals with such skills and experience can be difficult, even for successful and established family businesses. Managers, like investors, may be wary of potential intrafamily conflicts. Having a strong governance structure already in place can assuage these concerns.

Working with non-family managers will be a large adjustment for many family firms. The authors of the PwC survey suggest that a company "becomes less like a private entrepreneurial venture, and more like a public company"when outside managers are hired. This is at least partly attributable to an outside manager's ability to pursue business goals, such as global expansion and increased profitability, without being hindered by the "soft"—and often contentious—issues that are an inevitable part of family meetings. While this may bode well for a company's balance sheet, families should take steps to ensure that hiring professional management does not reintroduce conflict into the business structure and diminish the long-term return on investing in such individuals.

A manager who runs the company without any regard to the family values is likely to clash with family members who have transitioned from leading the business to being owner-investors. To avoid such discord, families should make managerial candidates aware of their core values and the systems in place for decision making. Families should ensure that the governance documents provide a meaningful way for owners to remain involved in the business, without necessarily managing it, and that an incoming managerial team understands such processes. Before bringing professional managers on board, family owners should honestly assess whether they are willing to step back and allow the non-family executives to run the business.

An increasingly popular strategy

Transitioning from management to ownership is a flexible succession planning strategy that has grown in popularity in recent years, owing in part to the rise in technology and globalization and the need for managers with skills in those areas. According to PwC's global family business survey, the proportion of respondents who expect to pass ownership of the business to the next generation while bringing in professional management rose from 25% in 2012 to 32% in 2014—just two years later. Although the transition from management to ownership has its challenges, with proper planning it can provide significant near-term benefits to a family business, while also substantially strengthening the family's business legacy.

David Guin, a partner and the New York office managing director with Withers Bergman LLP, leads the firm's U.S. commercial practice group. Mark Haranzo is the regional practice group leader of Withers Bergman's U.S. trust, estate and charitable planning group. Sarah Pickering is an associate in Withers Bergman's wealth planning group (www.withersworldwide.com).


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