The succession steps a family business can take

A high proportion of New Zealand businesses are family-owned and many of those families want to keep things that way. But, too often, the important conversations to make that possible, or to consider viable alternatives, don’t come soon enough.

Succession planning for family businesses can be tough. The assets are often illiquid and are imbued with sentiment and emotion. There is often pressure to keep the business within the family, regardless of practical considerations.

Business succession planning requires a holistic approach that stretches beyond the realm of the business into the realm of the family. It is therefore essential to understand the intricacies of a family business system that comprises three partially overlapping circles of family, ownership, and business.

Within this three-circle model, developed at the Harvard Business School in 1978, there can be as many as seven different stakeholder groups, each with its own legitimate perspectives and goals.

These include family members who own and work in the business, those who work in the business but don’t own it (or the other way around) and those who are not involved at all. Then there are non-family members who either own or work in the business, or both.

Once we grasp the make-up of a family’s business system, we can identify potential transition challenges from the perspectives of these diverse groups.

Challenges can be obvious, such as issues with the organisational structure, uncertainty around roles and responsibilities, the financial health of the business, and overly complex or not fit-for-purpose asset protection structures of the business owners.

Or they can be less visible, such as emotional tensions, family relationships, cognitive biases and owner psychology. Advisors should deliberately and strategically plan for these specific challenges rather than apply generic solutions to generic issues (real or imagined).

It is also crucial to do some contingency planning and plan for the unplanned. The Exit Planning Institute specifically identifies ‘The Five Ds’ for special attention: divorce, disagreement, disability, distress, and death.

There are no universal or fail-safe preventative measures for The Five Ds, but there are a few guiding principles:

Divorce (or separation): Negotiate a relationship property agreement with your spouse or partner, whether or not they are involved in the business, to agree how you will divide the ownership (and your other property) in the event of a separation. Avoid using collateral in the family home to finance the business. If the spouse or partner has an active role then there must be a person or a team ready and willing to take over their responsibilities in the event of a separation.

Disagreement: When dealing with a disagreement within the family, effective communication is essential. Develop protocols for the family to follow. Have a shareholders’ agreement to regulate how the family engages with each other in a business context. Clearly define roles, responsibilities, and desired actions for each family member.

Disability: Ensure the shareholders’ agreement or family charter provides for disability as well as life insurance. Appoint attorneys to deal with matters of personal property and personal care if a disability or medical event impacts a family member. Document business processes to limit the impact of disability on business operations.

Distress: Have a financial contingency plan to deal with unforeseen financial distress. This should include risk mitigation issues to deal with climatic events, workplace accidents, supply chain issues, biosecurity breaches, etc. Review insurance policies to ensure adequate financial provision and sufficiently broad coverage.

Death: Ensure there is insurance cover to provide funds to hire someone of similar calibre to fill any role vacated by the unexpected death of a key person. Make sure family members have wills to mitigate legal difficulties for dependents. Have comprehensive structural capital and documented processes for the continued success of the business when an owner dies.

If there is a scale to justify it and a capable management team can deliver it, a well-designed family governance programme can help with succession planning. It is about addressing how the various stakeholder groups and the advisors will communicate, solve problems, and make decisions together.

The essential ingredients of a family governance programme may include (depending on scale):

• A formal business succession plan
• A formal dividend and salary structure for family members working within the business
• Internal and external communications policies
• A family constitution or charter
• A family council/steering committee
• A family office (single/multi-family or virtual)

Key practices for an effective family governance programme require listening to foster understanding, setting clear roles and responsibilities between the board, management and advisors, and engaging family members based on their generation and their personal interests.

Succession planning is a process, not a transaction, even though it might eventually involve a transaction.

Best outcomes occur when succession discussions begin well in advance of any anticipatory transition. The challenge is to firstly overcome inertia to develop an appropriate, coherent, and agreeable strategy.