How to Choose a Successor
Practically as soon as a small or mid-sized business is successful enough to have a future, the business owners needs to start thinking about developing a plan for who will succeed them. In a public corporation, the board of directors has a fiduciary duty to the shareholders to develop and implement a succession plan. In a privately-held company, the business owner has the responsibility to think beyond him/herself and provide a succession plan for the benefit of employees, family, customers, and supplies. The planning may encompass who will take over the event of an untimely death or disability, the loss of a key employee, or when the owner no longer wants to be in charge.
"If this is such a crucial element of good business planning that it requires the attention of the boards of the world's largest companies, it is no less important for a small privately owned business where the 'bench' usually isn't very deep," says Otis W. Baskin, business professor at the Graziadio School at Pepperdine University and an associate of the Family Business Consulting Group, Inc. "Yet, it is quite possibly the last thing most owner-managers want to face."
The process can be more difficult for a small or mid-sized business because succession deals not only with management but ownership of the business, and ownership is usually in the hands of one person, a family or a partnership. Decisions to be made by the owners of private businesses fall into three general areas: sell, pass ownership and management of the business along to heirs, or let the family retain ownership but not management. These can often become complicated because of the involvement of different family members and their sometimes differing views of what is best. But there's no denying that keeping a business in the family can often yield more wealth for generations to come than any investments purchased from the sale of the business. When owners decide that preserving a successful business for future generations would be the best legacy they could leave behind, they need to begin the process of choosing a successor.
The following pages will cover how to choose who should succeed you, how to develop a succession plan to communicate that decision, and how to help pave the way for your successor to be successful.
Dig Deeper: Succession and Liquidity for Privately Held Companies
How to Choose a Successor: Developing Your Succession Strategy
There are all sorts of issues to consider when addressing the question of succession in your business: timing of the transition of power, the problem of who should succeed you and whether that will spark disputes in your family, and the matter of how you can best help the succession proceed smoothly. Various family business studies estimate that only 30 percent survive the transition from first- too second-generation ownership. Of those that do, less than half make it to the third generation. That's why one of your first orders of business is to understand your goals in succession planning.
"The goal is to keep operations running as smoothly as possible if the unexpected should happen and a key player is either no longer available or no longer able to perform," says Laura Willett, senior lecturer of finance at Bentley University and a small business consultant. "It's a bit like a professional sports team -- if we lost our key player how would the team continue to win? It's a matter of identifying a point person who could pick up the ball and run with it."
Start by answering the question: for whom or what positions in your business do you need a succession plan? No individual is indispensible (including the firm's founder) and given that anything can happen it's always best to have a plan laid out for who will cover the senior person or persons within a firm. In a smaller firm, personality is always a factor, Willett says, but the skills and/or key functions should be the guide in succession planning. If you were to lose the one person who could perform a specific critical function in the firm would this hamper "normal operations" -- if the answer is yes, prepare a plan to cover that person.
Selecting a succession target date
The goal of good succession planning should be to create a process, not an event, Baskin says. "Choosing a successor without a commitment to a target date is a common mistake," he says. "It will be difficult to keep a qualified successor, even if he or she is a family member, in place long without a timeline. Developing a plan to select a successor and a plan to implement the succession does not require a specific date for the event. Rather, a series of milestones leading to readiness for succession is usually best."
In selecting milestones and target dates, Willett says it is important to consider how complex your business and/or industry is. In addition, she says that you need to factor in how long it will take for the owner or senior manager to be comfortable with the transition. "The more complex the business the longer it will take for full understanding. Again, this is a bit of a balancing act," Willett says. "Making the dates too far out can discourage everyone involved. Generally letting any one milestone go beyond a year is going to reduce the effectiveness of the plan. If a target will take multiple years to complete, it's better to break it down into smaller, more manageable tasks."
How to pick a successor
In some businesses, it's a no-brainer to pick the right successor. It may be that there is only one family member who took a shine to the family business. Or perhaps it's someone from outside the family who has worked in the business and demonstrated the skills and personality to best lead the business into the future. But, oftentimes, succession is a much more difficult issue for businesses.
A lot of those difficulties stem from the fact that small businesses are often dealing with families in succession planning -- and not all family members agree where money is concerned.
"A lot of family-owned businesses use the business as a tool to train the next generation," says Bill Worthington, assistant professor of management and entrepreneurship at Baylor University, who has researched family businesses and was brought up in a family that owned a waterproofing business and struggled with succession issues. "In our story, as is very typical, there was a certain heir apparent but that didn't work out. And then there was another but there was a death in the family. I thought we were unique but these little soap opera stories apparently are quite typical."
A good succession plan should include criteria for the successor that reflect the needs of the business in the future. "If you're the current leader, avoid the temptation to 'clone' yourself," Baskin says. "It is critical to realize that your successor cannot lead the business just like you. Look for the right person to build upon what you have done and take it to new heights, not preserve your memory."
If more than one candidate has been identified as a potential leader, a sub-committee of the board or a group of trusted advisors can be asked to make a recommendation, Baskin says. This may be done over some specified period of time to allow the committee to observe each person in action if they are not already familiar with their work.
John Schoen, an adjunct management professor at Baylor who has done research with Worthington, says that even if the family remains as the controlling owners of a business, the successor to manage the firm doesn't necessarily have to be a member of the family. "In some instances, a non-family successor is better either in the short run or the long run," he says. "The family members may not possess the right qualities to run the business."
There is help for family-owned businesses in helping to develop succession strategies and plans. Businesses considering succession should consult with attorneys, accountants, and tax planners who specialize in family business succession to understand all the implications and get advice about choosing successors, Worthington says. The Family Firm Institute, a global non-profit think tank for advice and research into family business and the family wealth field, is also a resource for information, as its members consult with small businesses regarding the legal, financial, and tax implications of succession in businesses.
How to Choose a Successor: Developing a Succession Plan
Despite whether the next CEO will be a family member or not, there are some critical steps that the business owner must take to ensure the endurance of the business. Sometimes, a founder decides to leave the business to his or her children in a manner that creates a group ownership situation. "If that is the wish of the current owner or owners, they must prepare the next generation to be good owners, regardless of who is selected to be the next CEO," Baskin says. Many owner-managed businesses don't have strategic plans beyond the knowledge and instincts of the founder. It is necessary to prepare the business for succession by making sure there that there are plans in place that the next leader can understand and use to build upon.
Writing a succession plan
According to Craig Aronoff, Steven McClure, and John Ward, authors of Family Business Succession: The Final Test of Greatness (Aronoff, McClure, and Ward, 2003), there are several distinct plans that need to be developed to ensure a successful transition:
- Business strategic plan -- This type of document provides an outline of the future path of the business and it allows each subsequent generation to add to it and perhaps alter the course.
- Family mission statement -- If ownership will be shared among family members, you need to lay out the policies and procedures for the role of family members in the business -- whether or not a family member maintains day-to-day management of the business.
- An owner's estate plan -- To avoid losing the business to the government by paying higher-than-needed estate taxes, you need to understand the tax implications of ownership transfer to make sure your estate winds up in the hands of your heirs.
- A succession plan -- This written document defines how succession will be carried out, when certain duties or authority turns over to the successor, how to fill gaps in experience or knowledge identified during the selection process, and spells out how to determine the successor is ready.
How to Choose a Successor: Helping Ensure Succession is Successful
It is important to make certain that everyone knows when the process of succession is complete. "Visibility is key in any small to mid-sized firm -- the clearer and more specific the plan the more likely it will succeed," Willett says. "Identifying a key successor is not something you want to have flying around the company rumor mill."
Communicate the succession decision
One of the best ways to ensure that the succession plan is a success is to communicate it to employees, family, partners, and customers. This is particularly important if the founder or business owner remains active while the transition is under way. "If the former CEO continues to serve as board chair or in some other role, it may be difficult to break long established communication patterns," Baskin says. "This cannot be accomplished with a memo or e-mail. Meetings with key executives and external constituents need to be arranged to reinforce their understanding of the change in leadership."
It's important for the succession plan to be written down. Discuss with your advisors who you should share this document with, such as other owners, business partners, or family members. "If it hasn't been articulated and written down and if you don't understand it well enough yourself to put down in writing, then you don't understand what is supposed to happen," Worthington says. "A written succession plan may start with a napkin at Chili's over lunch but it has to morph into a formal document that includes buy-sell agreements. You could get awfully complicated with it. But the more detail there is the less uncertainty."
Detail evolving leadership roles for the founder and successor
One goal of a succession process should be to make the changeover a non-event in the eyes of key stakeholders. Worthington says he often cites the succession plan of General Electric, when former CEO Jack Welch stepped down, as a model of success -- even to family businesses. The company had been open about the selection process with employees, stockholders, and the public. "When he did retire, no one was shocked," Worthington says. "Everyone knew what was happening. The goal should be a flat line in business operations. There is a transition involved but not really a shock to the business."
The best process is one that seems natural and is expected by everyone involved, Baskin says. "This is best accomplished by gradually shifting decision-making and authority from the current leader to the next, allowing both leaders the opportunity to adjust to their new roles," he adds.
Make a plan for organizational succession
The organization itself may need to change with the appointment of a new leader. This is especially true when the transition is being made from the founder to the next generation of owner(s). "Governance and decision-making processes that were not needed when one owner-manager was running a business may need to be developed to guide the roles and safeguard the rights of the new leader and owners," Baskin says.
Remember that there may be bumps in the path to a smooth succession. "It isn't easy for the founder or entrepreneur to hand the mantle of leadership over and let go of their controlling interest in ownership," Schoen says. Ownership of the firm doesn't typically transfer at the same time leadership transfers. "You're going to see a delay there," he added. "Typically the older generation wants to see how the new folks do before they give them all the keys to the company."
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Publications and information related to family business succession.
The Family Firm Institute
A non-profit, international, professional membership association for advising and research into the family business and family wealth fields.
The Money Alert
Things to consider for your business before succession.
Advice for small business owners tackling the topic of succession.
Business Succession: The Final Test of Greatness Family
By Craig Aronoff, Stephen McClure, and John Ward
Family Enterprise Publishers, 2003
A classic resource on managing the challenges of planning for succession in a family business.
Another Kind of Hero: Preparing Successors for Leadership, Another Kind of Hero
By John Ward and Craig Aronoff
Family Enterprise Publishers, 1992
This book is focused on how to help the next generation in a family business rise to the challenge of leading the company.