One in five small businesses in the United States is family-owned, according to the experts at SCORE. Eventually, each of these businesses faces the same big decision: Who will run things when the founder is no longer around?
Most founders plan to keep their businesses in the family by passing it onto the next generation. However, the harsh reality is that few of them successful. Only about 30 percent of family businesses survive into the second generation. Even fewer — an estimated 12% — will see their businesses last into a third generation.
Why? Transitioning a business within the family is a complex undertaking with plenty of room for error. It requires long-term planning, comprehensive corporate governance structures, and an alignment of values and goals. Not only does the successor generation need to have passion and dedication for the business, but they also need to be equipped with the knowledge, skills, and support to succeed.
At Funding Circle, we’re proud that many of the businesses we help are family-run. They are at the center of their community, from the family itself to its employees, customers, and suppliers.
But sustaining a family business across multiple generations is no easy task. To help family businesses approaching an intergenerational transition, we asked some experts for their best tips:
Comprehensive planning well in advance of the change is critical, said Dr. Monika Hudson, director of the University of San Francisco Gellert Family Business Resource Center. She recommends that family businesses begin preparation long before they hand over the reins to a new generation.
“What happens, particularly with founders, is you’re spending the first five to seven years getting the business established. Once your head comes above water, you think that it’s about continuing to expand the business,” she said. “But concurrent with thinking about how to expand and scale the business needs to be, what are the structural pieces that need to be in place in order for scaling to be successful.”
Deryck Jordan, managing attorney at the law firm Jordan Counsel, agreed.
“The key is to plan well in advance. Think of it as a scaled-down version of post-merger integration planning,” he said. “Most importantly, the transition should occur at a time when a manager from the previous generation can remain on board for a fixed period of time to act as a consultant to the management team of the newer generation.”
Governance structures provide the framework and processes for communication and decision-making in business. At family businesses, these structures are often less formally defined than at non-family businesses — leaving room for conflict and miscommunication. Experts said that having a well-defined and well-implemented governance structure in place is a critical element of a generational transition.
“Building good governance takes time. You want to do it early when there are no issues,” said Professor Margarita Tsoutsoura, academic director of the Smith Family Business Initiative at Cornell University. “People are more likely to accept changes when the company is performing well, rather than accept changes at a time of crisis for the company.”
She added that these governance structures could help the family address one of the most common sources of tension during a transition period: managing liquidity. Managing liquidity can be an issue when one successor wants to “cash-out” on their share of ownership, while their fellow heirs wish to remain in control and grow the business.
“These infights can actually have a big effect on the performance of the company if the family doesn’t have mechanisms in place to solve them,” Dr. Tsoutsoura said. “If you plan ahead, you can allow family members to exit the business if they like, without creating liquidity problems in the firm.”
Founders also need to ensure their successors are ready and willing to take over. Dr. Tsoutsoura recommends preparing the next generation through formal education, as well as by giving them exposure to the company’s problems and allowing them to work in the business before taking it over.
“Founders also need to confirm that the next generation is interested in taking over the business at some point,” said business coach Stacy Caprio.
“What you don’t want is a misunderstanding where everyone thinks a transition is about to take place while in reality, the receiver of the business doesn’t want it, so the business simply dies out instead,” she said.
Cleve Clinton, a partner with the Dallas law firm Gray Reed who works with families going through generational transitions, recommends starting the planning process with three critical ‘whys.’
He outlines these as: