SUCCESSION PLANNING
Unresolved Succession and
Governance Issues Still Prevalent
Among Family Businesses

BY MIKE COHN

Almost 40% of family-owned businesses (FOBs) will change leadership in the next five years as CEOs retire, or semi-retire—yet 55% of those age 61 or older, have not chosen a successor, according to the 2002 American Family Business Survey of 1143 family businesses. For the next generation anticipating a leadership change, there is also a note of caution: 13% reported the current CEO will never retire.

And nobody seems to be talking about it. Amazingly, almost 40% of significant shareholders do not know the senior generation's share-transfer intentions. For these, future family ownership is a mystery with implications for family conflict.

Since CEO's tenure in the top spot at an FOB is generally six times longer than their counterparts in public companies, these turnovers are expected to trigger power shifts in family relationships when CEOs step down—a risky proposition when the process is not managed or is shrouded in secrecy.

Privately-owned FOBs do not use their boards of directors in the CEO succession process: about half say their boards meet only once or twice a year, while 13% say they never meet. Of those that do have active boards, most (70%) don't have subcommittees (audit, compensation, etc.); and while almost 60% of those with active boards cite their board's performance as good or outstanding, a substantial number report weak board performance.

The problem may be the board's size and makeup. Privately-held FOBs report only three­ or four-member boards (88%) with 90% reporting family members having at least two of the seats.

Who's next?
While many CEOs have not identified their successors, the survey also points out their top concerns are management strength, along with domestic competition—implying an intellectual "gap" that is not being addressed.

Although most respondents (88%) want their businesses to remain family-owned, most (60%) do not have written strategic plans, raising questions about the next generation's capabilities to evaluate risks, opportunities and strategic thinking among management.

FOBs over the past five years, have experienced changes: 39% have had a family member cease employment in the past five years, 21% have had a divorce in the family, 36% have bought out a family member, and 25% have repurchased some of their shares. Formal valuations are done annually or bi-annually by 58% of the respondents, suggesting that many FOBs may lack timely information about the value of their businesses.

Next generation leadership
The current CEO's job is overwhelmingly (93%) held by a family member related by blood, adoption or marriage. The uncertainty about CEO succession may indicate concerns about the next generation's ability to head up these complex organizations.

Of those who currently use "outsiders" in the CEO role, most (71%) report that it has been an extremely or very successful experience. In some cases, the outsider can provide a "bridge" between current and next-generation family members, providing mentoring and experience until the next generation is prepared to take over the company.

Query: Will a greater number of FOBs look to professional outsiders to run their companies in the future so that the family can retain ownership? If so, then maintaining the corporate culture (when bringing an outsider in) and formalizing family governance will become major topics for current and future owners to address.

Ownership plans are changing
The average respondent reported over $36 million of gross revenues and an average of 50 employees. Nearly 29% plan an equal division of ownership among next generation family members. In 1997 that number was 24%; sharing ownership among "actives" and "inactives" is therefore increasing.

Also, in 1997, 30% intended to give greater ownership to those who worked in the company. That number declined to 22% in the current survey.

Implications
There are plenty of questions raised from this survey about governance and ownership, CEO succession and the role of the board. Of course, this raises further questions about the board's linkage with owners. How can the next generation become smart owners if there are no written strategic plans? And how does the board, or others, know how the company is doing against the plan when it isn't written?

If management strength is a concern, then why isn't leadership development a priority? Is the traditional family-conflict ­avoidance style of the current CEO causing procrastination about tough issues of next generation competency?

Low debt levels (26% report no debt other than trade payables) coupled with increasing shareholder buybacks and liquidity needs may create a future capital "crunch" which may become acute when inactive shareholders demand greater liquidity and the business needs capital to grow.

As ownership is shared among family members, it will become increasingly important to have a place and voice for these issues to be aired—and a process that permits this to happen. If ownership is to remain in family hands, then tough issues such as CEO succession and management competencies need to be tackled by current and next generation owners now.