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THE FAMILY BUSINESS SUCCESSION CONUNDRUM
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Mittelstand is a term used in Europe to describe the small to medium enterprises, mostly in the business of manufacturing exports, which can be found in the smaller cities and communities throughout Germany, Austria, and Switzerland.

The defining quality of the Mittelstand has more to do with corporate philosophy and practices than size or product. Generally speaking, these businesses tend to have been family owned for several generations. They tend to operate conservatively with an emphasis on long-term stability, continuity of ownership, independence, innovation and emotional attachment. These businesses often make significant investments in social responsibility, employee benefits, wellbeing and regional development. As a result, these businesses tend to generate loyalty and goodwill from management, employees and the wider community. Above all, these businesses tend to be very successful.

In New Zealand we have our own version of Mittelstand comprising so called SMEs and family owned commercial enterprises. Whilst the sector is nowhere near as renowned or well performing in global terms, it is the lifeblood of the economy. Furthermore, the valuations of some of these businesses (and I include family farms in this) have increased exponentially in recent decades due to a combination of factors including sound management, good governance, cheap credit, favorable trading conditions, low sovereign risk, underlying asset inflation and calculated risk taking.

The opportunity we have now is to preserve and enhance these businesses in Mittelstandfashion, rather than allow them to be fragmented and diminished by short term thinking.

The family business succession conundrum

Much has been made of a pending tidal wave of family business succession and liquidity events as the Baby Boomer generation transfers assets and control to the next generation, whether in a planned and orderly fashion (such as a public listing, trade sale, private equity sale, MBO or phased family succession) or otherwise forced by events and circumstances (such as death or incapacity). However, in my experience, significant psychological obstacles are leading to a disconnect between strategy and execution in this area. What I mean is that family business owners, lawyers, accountants and bankers all know that succession planning is important but we often fail to fully grasp the human elements at play. Make no mistake, this is not a science, it is all about human behavior around money which is often irrational. Sometimes intellectually brilliant succession plans are formulated but never see the light of day.

A consequence of this can be that even the most diligent business owners often neglect or avoid having meaningful succession discussions. By the time they really need to engage their position may be weakened and valuations compromised.

Any plan is better than no plan

A family business succession plan may be quite simple – for example, sell or wind up the business and distribute the proceeds among the family or, alternatively, transfer the business to a “Crown Prince” or “Crown Princess” (i.e. a designated child who has historically been involved in the business) for continued operation.

Some succession plans may be more complex and anticipate equity sharing between siblings, capital raising (public or private), diversification, expansion into new markets or restrictions on issuing equity to non-family members.

For some wealthy families the succession plan might be contained within a charter or constitution which governs the family and its various business and investment entities. For other families, the succession plan may be as simple as having a trust (whether created before or on death) which holds equity in the family business and a detailed memorandum to deal with the devolution of control and guide the trustees in the exercise of discretionary powers.

Some business owners may wish to hard wire the future direction of the business by imposing very prescribed rules on the next generation. Others may be willing to be more flexible and allow them to work within a framework of guiding principles, rather than rules.

Both approaches can work and may involve a combination of traditional estate planning techniques together with corporate and commercial tools, such as put and call options, drag along and tag along provisions, rights of first refusal, rights of pre-emption, redeemable preference shares, shareholder/beneficiary loan accounts, minority shareholder protections, employee share schemes, family share schemes, and earn out provisions, etc.

Philanthropy may also be an important feature in any such plan.

Best outcomes

In my experience, the best outcomes:

1. occur when succession discussions begin well in advance of any anticipated transition;
2. require an in depth understanding of the family dynamics drawn from considerable time and effort in understanding and meticulously documenting all the relevant circumstances;
3. involve engagement with all stake holders, including family members and management;
4. are based on a game plan, which is simple, documented and agreed at the outset before any substantive steps are taken;
5. are not tax driven;
6. involve the founders taking a leap of faith in the advisors, management and family members;
7. involve the free flow of information between the lawyers, accountants, bankers and other relevant professionals who work together from the outset, rather than alone in silos;
8. are often led by professionals skilled in the science of human behavior – rather than lawyers and accountants; 
9. are predicated on independent valuations and reporting;
10. take into consideration financial products such as insurance to manage risk and annuities to manage cash flow and services such as wealth management, where there is liquidity;
11. distinguish between the very different functions of advice, management and governance; and
12. recognise the value of independent governance, whether that be at trust or company level (and in this regard, the family lawyer and accountant may not always be “independent” and perhaps should concentrate on advice rather than governance, which involves a different and much wider set of fiduciary responsibilities).

A well-designed family business succession plan can articulate the vision and values of the founders and help ensure a smooth transition to new owners or the next generation. There are many examples where careful and sometimes innovative planning has led to the aggregation of wealth and inter-generational prosperity for future generations of the family and the communities in which they live and work.

The challenge is to overcome the disconnect between strategy and execution. If we can do that then our own version of the Mittelstand (perhaps Kiwistand?) can continue to fuel the New Zealand economy, bind communities and stimulate regions for generations to come.

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