Leo Tolstoy begins Anna Karenina with the line: “Happy families are all alike; every unhappy family is unhappy in its own way.” Much the same can be said for successful multi-generational family businesses as well as family businesses that are unsuccessful in succession planning. Successful multi-generational family businesses are all alike; they follow certain tried and true succession planning best practices, with a particular focus on family dynamics, to ensure that the business passes successfully to the next generation. Family businesses that fail to plan for proper ownership or management succession typically are unsuccessful in succession planning because they allow unique family dysfunctional behavior to replace the necessary best practices for proper succession. As a result, they not only destroy the family business, but also frequently destroy the very fabric of the family itself.

Successful family business succession planning is an evolutionary process that requires tremendous effort by the family and its advisors (including non-family managers) over many years. Although a deep understanding of business strategy is important to succession, it pales in comparison to the importance of family dynamics to a successful succession plan. The business owner or advisor who ignores family dynamics in a succession plan does so at his peril. The most critical issues related to a successful family business succession are family-related rather than business-related. In “Correlates of Success in Family Business Transitions,”1 the authors of the study found a consistent pattern of factors that led to breakdowns in the succession process. Sixty percent of succession plans failed because of problems in the relationships among family members. Twenty-five percent failed because heirs weren't sufficiently prepared to take over ownership and management of the family business. Only 10 percent failed because of inadequate estate planning or inadequate liquidity to pay estate taxes. That means that 85 percent of family businesses fail in the succession process due to inadequate planning to resolve intra family disputes over the business and the inability to groom successors to run the family business.

Yet families who take seriously their stewardship of the family business from one generation to the next can be surprisingly successful in effective succession planning. The New York Times, Car gill and S.C. Johnson are three examples of companies that have successfully transitioned more than three generations. In fact, the oldest family business operating in the United States is The Avedis Zildjian Company Inc. (a producer of cymbals), which was founded in 1623 in Constantinople and moved to the United States in 1929.

Some Statistics

Approximately 90 percent of U.S. businesses are family firms, ranging in size from small “mom-n-pop” businesses to the likes of Walmart, Ford, Mars and Marriott. There are more than 17 million family businesses in the United States, representing 64 percent of gross domestic product and employing 62 percent of the U.S. work force. Thirty-five percent of the businesses that make up the S&P 500 are family controlled. Family businesses are also more successful than non-family businesses, with an annual return on assets that's 6.65 percent higher than the annual return on assets of non-family firms. Unfortunately, only a little more than 30 percent of family businesses survive into the second generation, even though 80 percent would like to keep the business in the family. By the third generation, only 12 percent of family businesses will still be viable, shrinking to 3 percent at the fourth generation and beyond.2

Family Dynamics

The disconnect between what 80 percent of families intend and the far bleaker reality, can in part be attributed to a failure to plan effectively for the family dynamics issues involved in family business succession. Fortunately, over the past three decades, both academics and practitioners have studied and written about the family dynamics issues that are crucial to successful family business succession. We now have a large body of reference material to rely upon. Family business commentators come at the family dynamics issues involved in succession in their own way, sometimes based on whether they're organizational psychologists, business strategy experts, historians, sociologists, economists, accountants or trusts and estates attorneys (like the always inspiring James (Jay) Hughes, Jr.). While an exhaustive discussion of the various theories is beyond the scope of this article, a discussion of the following aspects in three seminal books on family business succession planning communicates certain universal themes: (1) “family businesses as systems,” as described in Generation To Generation, Life Cycles of the Family Business, by Kelin E. Gersick, John A. Davis, Marion McCollum Hampton and Ivan Lansberg3 (Generation to Generation), (2) the “Five Insights” and the “Four P's” from Perpetuating the Family Business: 50 Lessons Learned from Long-Lasting, Successful Families in Business, by John L. Ward,4 and (3) the “three stages of succession,” from Succeeding Generations: Realizing the Dream of Families in Business, by Ivan Lansberg5 (Succeeding Generations).

Family Businesses as Systems

Perhaps the best-known family dynamics theory for family businesses is the three-circle family business systems model (see “The Circle Game,” p. 18), first developed by John A. Davis and Renato Tagiuri at Harvard University in the early 1980s. As described in Generation to Generation, the model defines the family business system as three independent but overlapping subsystems: (1) family, (2) ownership, and (3) business. Each person in a family business is placed in one of seven sectors formed by the overlapping circles of the subsystems. All owners, and only owners, are placed in the top circle. All family members are somewhere in the bottom left circle. All employees are in the bottom right circle.

A person with only one connection to the family business will be in one of the outside sectors (1, 2 or 3). For example, a family member who is neither an owner nor an employee will be in sector 1. An individual who is an owner but not a family member or employee will be in sector 2. An individual who is an employee but not an owner or family member will be in sector 3.

Those individuals with more than one connection will be in one of the overlapping sectors, resulting in that person falling within two or three of the circles at the same time. An individual who is an owner and a family member but not an employee will be in sector 4, which is within both the ownership and family circles. Someone who is an owner and an employee but isn't a family member will be in sector 5, which is within the ownership and business circles. An individual who is in the family and works in the business but isn't an owner will be in sector 6, which is within both the family and business circles. Finally, an individual who is an owner, family member and employee will be in the center sector 7, which is within all three circles. It's important to note that every person who is part of the family business system has only one location within the three circles.

The three-circle model is a highly effective tool for identifying and understanding the sources of interpersonal conflicts as well as role and boundary issues in family businesses. Specifying different subsystems and roles helps to simplify the complex interactions within the family business system. Understanding family business succession is much easier when all three subsystems — family, ownership and business, with their various interactions and interdependencies — are analyzed as one system. The goal is to create an integrated system that provides mutual benefits for all system members. By identifying the position of each member of the family business system within the three circles, it's easier to understand the motivations and perspectives of the individuals as determined by their place in the overall system.

The three-circle model creates an effective snapshot of a family business at any particular point in time. According to Generation to Generation, this snapshot is an important first step in understanding family dynamics in a particular family business. But as a family business enters a period of transition during business succession planning, people enter and leave as well as change their positions within the circles over time. Therefore, the authors of Generation to Generation believe that it's important to see how the whole family business system changes as individuals move across boundaries inside the system over time. Adding the dimension of time to the three-circle model allows for a more accurate understanding of the family dynamics issues as the succession plan progresses over time.

Five Insights

According to Ward, there are certain overarching principles common to the world's most successful and enduring family businesses. He refers to these as the “Five Insights” and the “Four P's” and he considers these concepts “the framework and foundation for family business continuity.” The Five Insights represent seminal concepts that connect family life and the operation of the business into an integrated whole.

Insight #1: Respecting the challenge

Successful business families understand that the odds are against them when it comes to passing the business to the next generation, says Ward. Because of this knowledge, they take succession planning very seriously and put enormous amounts of time and effort into it. They embrace the challenge, educate themselves and take the steps necessary to foil the adage of shirtsleeves to shirtsleeves in three generations.

Insight #2: Common issues but different perspectives

Ward believes that successful multi-generational family businesses understand the following two concepts: (1) virtually all family businesses share the same problems and issues, and (2) different people within the family business system see these same problems and issues in predictably different ways depending on their position within the family business system.

Understanding that a family business isn't alone in the problems and issues it faces empowers a family to gain the knowledge necessary to perpetuate the business from one generation to the next. And understanding that how a family member or non-family manager perceives succession issues depends on his position within the family system requires the family to respect each and every perspective and accept that it's healthy to disagree.

Insight #3: Communication is indispensable

Successful business families work very hard at encouraging effective communication. Lack of communication and an abundance of family secrets are significant factors in business families that are unsuccessful in passing the business to the next generation. Effective communication requires putting in place the forums and structures necessary to promote open dialogue. Ward finds that successful business families put in place the following structures to encourage communication: (1) formation of an independent board of directors for the business, and (2) beginning the process of having regular family meetings.

Insight #4: Planning is essential to continuity

Proper planning is crucial to the success and continuity of a family business. It's also more complex than planning for non-family businesses. Ward uses a concept he calls the “Continuity Planning Triangle” to illustrate the challenges unique to planning in a family business. (See “The Shape of Planning,” this page.) Business-owning families have to plan simultaneously on the following four different levels: (1) business strategy planning, (2) leadership and ownership succession planning, (3) estate and personal financial planning for family members, and (4) family continuity planning (in the middle of the triangle).

Business strategy planning deals with answering the question, “Where are we going as a business?” In the family business context, Ward believes that the business strategy plan is interdependent with leadership and ownership succession planning. Estate and personal financial planning is often a significant weak link in family business succession. Most family members have little cash flow outside the business and are dependent on the business for their financial security. Without significant assets outside the business, the senior generation may feel uncomfortable handing over the reins. It's crucial that family members begin the process of wealth generation outside the business as early as possible. This means contributing to retirement and profit sharing plans instead of reinvesting everything in the business. It also means thinking about where the liquidity will come from to pay any estate tax. Family continuity planning results in a family mission statement or constitution which sets forth the ideals and guiding principles that allow family members to act for the greater good of the family rather than in their own self-interest.

Insight #5: Commitment is required

Family businesses must be committed to: (1) the family's purpose, (2) planning for the future of the family, (3) having effective family meetings, and (4) the business and its continuity within the family.

The Four P's

According to Ward, the Four P's deal with the fundamental paradox in family businesses: What the family needs to be strong and healthy frequently conflicts with what the business needs to be successful. Families resemble socialist institutions in which people are treated equally, membership is permanent and interaction is primarily emotional. Business, on the other hand, is basically capitalistic. People are treated differently depending on their perceived contributions, and behavior is typically rational and objective. Because family and business systems have such different rules and norms, the two systems send conflicting messages over issues such as who gets hired and promoted, compensation of family members and which family members run the business. Ward believes that successful business families acknowledge the inherent conflict and contradictions between the family and the business as inevitable, and they employ the Four P's to minimize or avert any conflict these contradictions can create.

  1. Policies before the need

    Successful business families don't wait for a conflict to arise before they establish policies on predictable issues. They put in place employment policies before they're needed, setting forth the requirements for family members who want to join the business. These policies also deal with issues such as compensation and performance appraisals. By putting such policies in place at the start, the family can deal with issues as they arise and avoid emotional reactions. Such policies also help manage expectations on the part of family members. They allow the family to be more objective than they would be if they had to make the decisions in the heat of a crisis. In addition, by setting forth which behavior is appropriate, the policies help avoid conflicts.

  2. Sense of purpose

    Successful multi-generational business families focus a great deal of attention on defining a sense of purpose for the family, including the family business. This sense of purpose will be different for each family, but such an overarching purpose can significantly assist the family in perpetuating the family business in times of strife and conflict. A sense of purpose sustains a family business from one generation to the next.

  3. Process

    Even if a business has policies in place before they're needed, a time will come when a significant unexpected issue arises. The process the family uses to resolve these unexpected issues is crucial to the continued success of the family business. How the family communicates, solves problems, collaborates and reaches consensus may vary from family to family, but one theme unites successful business families: They look for win-win solutions to the difficult problems.

  4. Parenting

    Although it may sound strange to discuss parenting as an important factor in successful business successions, it's indeed a crucial factor in family business succession planning. Good parenting lays the foundation for how family members will engage each other in the family business. Parents can help children learn proper values and lessons about communication, wealth, being responsible and working as a team. Proper parenting can also help create a healthy relationship between the family and the family business.

Stages of Succession

Many commentators, including Ward, speak of the need to look at succession planning through the lens of the specific stage that the business is in during succession. In his book, Succeeding Generations, Lansberg does an excellent job putting the concepts of the stages of succession in perspective. According to Lansberg, family businesses come in three fundamental forms: (1) the controlling owner, (2) the sibling partnership, and (3) the cousin consortium.

  1. Controlling owner

    Controlling owners are in charge of all aspects of the family business. They make all of the major decisions and delegate very little. Because of their economic clout and strong personalities, controlling owners cast a large shadow over their families. This is particularly the case if the controlling owner is also the founder of the business. Controlling owners typically answer to no one other than themselves. They rarely have a functioning board of directors. If there's a board, it simply follows the controlling owner's directions. Passing the reins to the next generation isn't easy for most controlling owners. A controlling owner may be a hard act to follow and unwilling to step aside.

  2. Sibling partnership

    In this form, the ownership is divided more or less equally among a group of siblings, each with a fairly equivalent amount of power. Unlike the controlling owner, sibling ownership requires that the siblings be accountable to each other, and that they consider each other's needs, perspectives and preferences. Sometimes a sibling partnership is set up in a first-among-equals form, in which one sibling is the acknowledged leader. Other times, sibling partnerships take a shared leadership form, in which the siblings act as an equal team. The form that a sibling partnership takes (first-among-equals or shared leadership) can have major implications on how succession unfolds in the next generation.

  3. The cousin consortium

    The cousin consortium is characterized by fragmented ownership, so that over a period of several generations, ownership has been distributed among various branches of an extended family. Managing the dynamics of this fragmented ownership among various branches of an extended family can be very difficult, particularly when it comes to reinvesting in the business versus paying dividends. Successful cousin consortia begin to buy out those family members who aren't interested in the business and put in place structures such as family holding companies, truly independent boards and even non-family CEOs.

Transition Among Three Stages

According to Lansberg, the three stages are fundamentally different in both structure and culture. Succession planning strategies that work well in one stage can be a recipe for disaster in another. From a succession planning standpoint, each stage must be viewed as unique and decisions must be made in the context of the stage that the particular family business is in, as well as the stage it will be in after the succession is complete. For example, a transition from a controlling owner form to a sibling partnership form will require a fundamental change in the leadership structure of the family business. Similarly, when a sibling partnership is transformed into a cousin consortium, there's another complete redefinition of authority and governance structures in the family business.

As estate planners, we tend to focus on structures that ensure that a family business is passed to the intended beneficiaries in the most tax-efficient manner. We often only represent the patriarch, matriarch or both. It's important that we don't ignore the family dynamics issues that are so crucial to effective family business succession. If family dynamics issues cause 85 percent of succession failures and only 10 percent of estate and tax issues, perhaps we're not spending enough time understanding how poor family relations can destroy the beautiful estate plan we put in place.

Endnotes

  1. “Correlates of Success in Family Business Transitions,” Journal of Business Venturing 12.285-501 (1997).
  2. Family Firm Institute, Inc., Global Data Points, www.ffi.org/default.asp?id=398.
  3. Kelin E. Gersick, John A. Davis, Marion McCollum Hampton and Ivan Lansberg, Generation To Generation, Life Cycles of the Family Business, Harvard Business School Press, 1997.
  4. John L. Ward, Perpetuating the Family Business: 50 Lessons Learned from Long-Lasting, Successful Families in Business, Palgrave MacMillan, 2004.
  5. Ivan Lansberg, Succeeding Generations: Realizing the Dream of Families in Business, Harvard Business School Press, 1999.

David Thane Lei bell is a partner in the Stamford, Conn. and New York City offices of Wiggin and Dana LLP