Generational succession sounds simple enough.

…until things go out of hand and the family is in dispute.

For starters, it’s important to note that generational succession must be managed as closely and diligently as if you were selling your business to a stranger to avoid misunderstandings – you need to make sure the transition goes well and that everyone commits to their roles and responsibilities.

If you are looking to hand your business to your children or relatives, there are a few key issues for you to think about:

Capability and willingness of the next generation – do your kids really want the business?

There needs to be a realistic assessment of whether or not the business can continue successfully after the transition. In some cases, the exiting generation will pursue generational succession either as a means of keeping the business in the family, perpetuating their legacy, or to provide a stable business future for the next generation. All of these are reasonable objectives, however, they can only work if the children are capable and willing.

The alternative scenario can also exist where it is the younger generation that pursues the generational succession. In some cases, children see it as their birthright, and in these cases, the willingness will exist but this does not automatically translate to capability.

In either case, the answer needs to be ‘yes’ to all of the following:

  1. Is the next generation willing and sufficiently committed to take on the responsibility of the business?
  2. Do they have the capability to operate and run the business?
  3. Can the capital value of the business be maintained and enhanced over time under their management?

Capital transfer – how much money needs to be taken out of the business during the transition?

What level of capital do the business owners (parents) need to extract from the business during the transition? It’s important to note that as the level of capital need arises, the pressure arises as well.

In the most cases, the incoming generation will not have sufficient capital to buy out the exiting generation. This will require the vendors to continue investing in the business or it will be in debt. Either scenario clearly needs an assessment to secure sustainability.

It’s very important to map out the capital transition both from a business and shareholder perspective. No generational transition should be undertaken without a clear and agreed capital program. Someone should also initiate to document all significant decisions. 

Income needs – ensuring remuneration is on commercial terms

In many small and medium-sized enterprises (SMEs), the owners arrange their payments according to their needs instead of basing the compensation on the roles undertaken.  This can result in the business either paying too much or too little. Under a generational succession, there should be an increased level of formality around compensation to directors and shareholders. Furthermore, all performance incentives must be based on a clear structure.

The compensation for all executives should be agreed at a business level first. Thereafter, all of the parties can assess the adequacy of the compensation to their needs and expectations.

Operating and management control

Once the capability and capital assessments are complete, it’s now time to look at the transition of control. This can be a very sensitive area. The establishment and transition of the operations management control is very pertinent since adverse business impacts are likely to occur if uncertainty exists around decision making.

Tensions easily arise because of the following:

  • Incoming generation’s desire to make their own decisions and have their imprints on the business
  • Incoming generation’s need to have an operating control
  • The exiting generation’s belief that their experience is necessary and that it entitles them to a continued say
  • A perception that capital investment should equate to ultimate operating control
  • An uncertainty by either or both generations about the extent of their ongoing roles

To try to prevent this, all parties must document and sign the plans and timelines for operating and management control.

Transition time frames and expectations

Generational succession is a process that materializes over an extended period of time. It’s quite different from the usual transaction where the owner’s involvement ends shortly after the sale. The extended time frame for the transition requires active management to ensure that there are mutual expectations.

The exiting generation may have identified that they want to scale down their business involvement and bring on other family members to succeed them. This does not necessarily mean that they want to withdraw completely. An extended transition period is not uncommon and can often assist the business in managing the change. This can also work well in managing income and capital withdrawal requirements.

The critical issue here is to identify and ensure that all of the parties have a common understanding and acceptance of the time period over which the transition will take place.

The need for greater formality and management structure

Generational succession often requires a greater level of formality in the management and decision making process. This formality should achieve a separation of function between:

  • Management;
  • The Board of the company; and
  • Shareholders.

Often, in a small and medium-sized enterprise (SME) business, these roles merge and there are no clear dividing lines or boundaries, which is why owners must set roles, responsibilities and clear key performance indicators (KPIs) to set things straight. For management, this needs to include clear job descriptions, authority levels and operating expectations.

Generally, a business requires a formal and functioning board of Directors, this includes outside members who can act as non-executive directors, for they can provide the balance between the two generational groups. The functioning Board should meet on a regular basis and direct management in the strategic direction of the company.

Managing and maintaining family relationships

A key component of generational succession is the ability of both parties to separate business from family matters. Understandably, this can be problematic and requires a significant amount of discipline by the participants, most especially on the part of the exiting generation.

Business tensions and differences in view about the direction of the business, and certain management decisions can bring significant pressure to normal family relationships. Grandparents and parents must ensure they separate their roles as family members and as fellow Directors and Shareholders. While these aren’t business issues, they are significant matters in a generational succession. Ultimately, any breakdown in family relationships will have some impact on the business (and vice-versa).