Passing the Family Enterprise Baton – A Decision Tree Tool Can Help

“It’s a Hard, It’s a Hard”

According to a study conducted by Family Enterprise Canada, 75% of family businesses are owner-managed, and of those, 15% transition to the second generation and only 3% transition beyond the second generation. When I first read these statistics, I thought to myself, “what a shame.”  After all, it is hard to build up a successful family enterprise, only to have 3% pass down to Gen 3. What a tragedy! 

After working with countless families to help validate their most logical continuity plans, I have determined that the reason so few family enterprises pass down to the next generation is because it is frankly the best decision for the family. Ok, I said it.

These days, the sale of a family business does not mean the end of the family enterprise. To the contrary, many families are reimagining and reinventing their family businesses from operating businesses to actively managed investment businesses and family offices. It is not a failure whatsoever to reinvent a family enterprise in that manner. And they still need good governance for successful continuity. Preparing for the passing of the baton is still very present even if it is not top of mind.

Family members sit in the Family Circle under the “3 Circle Model,” developed by Professors Taguiri and Davis at Harvard Business School, in their analysis of the different perspectives interested in the outcome of a family enterprise transition. Family members have a vested interest in the successful outcome of every family enterprise transition, to ensure they still get along, and avoid the breakdown of family harmony. 

To optimize the outcome of family harmony, good governance systems are needed in each of the 3 circles (Family Circle, Business Circle and Ownership Circle) to ensure a successful continuity plan. According to a research report by Family Enterprise Foundation (FEF) in 2021, called “Ready, Willing And Interested – or Not? Canadian Family Business Transition Intentions,” ownership of more than 60% of Family Enterprises will be changing hands within the next decade.  That is the largest and most valuable transition of family business wealth in Canadian history.

The fact is, it is hard to build good governance systems to successfully pass an enterprise down over the generations, and a lot of advance planning is needed. Let’s face it, in the early years, it is easier to manage the family dynamics, as there are fewer decision makers, egos, owners and collaborative decisions needed.

FEF’s latest study also states that the two greatest concerns found in passing on the business are: the next generation is not ready and the next generation members are not interested. Is this just perceived, or is it the truth? Good open communication is the key to being sure. Think of it as a relay race, the runners need to be sure they are running the same race and on the same team. Then both the person handing off the baton as well as the one receiving it must train and learn their role and responsibilities. Only when all parties involved are part of and are fully aligned in the process can the baton be passed successfully.

As the family enterprise baton is passed down from one generation to the next, decisions move from Founders (Founder-Owners) to their Children (Sibling Partnerships), then to Cousins (Cousin Consortiums) and finally to more diluted relations (Family Syndicates). 

Besides the inter-family personal reasons that transitions can be challenging, there are also financial considerations. If the owner needs the proceeds from the sale of the business to finance their lifestyle, it is financially more challenging to pass the enterprise down to the NextGens. And market conditions, health considerations, and preparedness of the NextGen (and their desire to take the baton) also greatly influence the decision to pass the family business on or to sell. 

When Family Enterprise Advisors counsel owners of a family enterprise on the conditions needed to ensure a successful inter-generational family transition, we typically say, let’s think ahead: “imagine you are your great-grandchild (i.e., Gen 4), in 60 years’ time. You have just inherited your family enterprise, along with 15 second cousins”. What governance mechanisms do you need to have in place to accept the baton as a successful Gen 4 active owner, as part of a family syndicate? And what skills do you need to possess, attitudes and values do you need, and who has formally mentored you in preparation? 

Research has shown that the best governance systems for the Family Circle include a Family Constitution, Family Counsel, Family Meetings, and a Family Assembly, along with tools such a pre-nuptial agreement.  But how many families actually have these in place, understand when and how to build them, or know who to turn to for help?

The Family Enterprise Advisor community is uniquely placed to help families navigate this challenging family enterprise lifecycle path.

The best time to start a successful family continuity plan is NOW! If the current stewards are prepared to invest the time, energy, and money to develop governance systems for tomorrow’s generations today, they stand a better chance of maximizing the successful outcome.  Conversely, if they aren’t willing to invest in what’s needed, maybe the best decision is to sell the enterprise to avoid the repercussions of an unsuccessful transition.  And that, very likely, is why only 3% of all family businesses pass beyond the second Gen.  Of course, even if there is a business sale, it doesn’t mean that the family cannot establish a Family Office with the proceeds of sale, as the new enterprise for future generations to be a part of.

Perhaps Bob Dylan said it best way back in 1962: “it’s a hard, it’s hard, it’s a hard, and it’s a hard, it’s hard rain’s a-gonna fall.” Don’t let the rain ruin your family enterprise succession. 

To help you navigate this challenging process, a couple of FEA colleagues have collaborated to design a “decision tree” as a tool for the FEA community.  We hope you find the tool, and series of articles on the topics helpful to assist you make the best decisions possible. Take your time as there is a lot of information and reflection needed to properly answer the questions presented.