Ideas that Matter MIT Sloan, 2019
What to Watch When Planning a Family Enterprise Succession
Walmart, Comcast, Nordstrom, BMW, Ikea, Zara, Lego, Samsung — all multibillion-dollar empires, all family companies. These companies testify to the power of the family business model, in which ownership is controlled by a single-family and two or more family members significantly influence the direction of the business through management or governance roles, ownership rights, or family relationships. Most of the world’s businesses, in fact — including many of the largest ones, even among those that are publicly traded — are family companies.
While family companies can be superior performers and leaders in innovation, all forms of enterprise have their weaknesses. One vulnerability of family companies concerns the transition of ownership and leadership between generations. Most of these transitions are not managed well enough and too many end in failure for the company and family. This is especially true of the transition between the founder and next generation, but this vulnerability persists in any generation of family control.
All this is according to John Davis, a senior lecturer in the MIT Sloan Executive Education family enterprise programs. Davis has spent four decades studying, teaching, and advising family-owned enterprises on how to sustain their success over the long term, including the pivotal transition of leadership from the senior generation to the next. Davis offers key guidelines for family businesses that are facing a shift between generations. While each generational transition presents distinctive challenges, these four management principles apply universally.
Momentum, or forward movement of a business or family, “is an underappreciated force that we need to be very respectful of,” Davis said. “If you kill, stall out, or even significantly reduce the momentum in a system, it’s hard to make it up.” Families need to steadily grow their financial assets, develop talent for the whole enterprise, and maintain group unity to stay ahead of company, family office, and family-related challenges.
Maintaining momentum must include preparing for and willfully making a transition from one generation of ownership, governance, and leadership to the next. Steady progress towards the goal of a successful handoff is a far better strategy than ignoring preparation and taking your chances at the end of a generation. Davis likened this to handing off a baton in a relay race: Both generations need to be running at the same speed for a smooth pass.
You need to pass the baton when the next generation is ready to lead — not when you’re ready to leave.
This analogy nicely captures the importance of timing. Transition from one generation to the next too soon and you will likely stumble. Delay the transition too long, and the next generation may be detached from and uninterested in the work. Growth can stagnate. Morale and unity can crash. According to Davis, the right timing hinges on one central consideration: “You need to pass the baton when the next generation is ready to lead — not when the senior generation is ready to leave,” Davis said. “And that’s an understandably tough principle to expect the senior generation to champion.”
No company head or leader of any enterprise organization, especially a founder with a deep personal investment in the company or family office, wants to leave “the game” that they are good at and enjoy playing, Davis said. To facilitate timely transitions, leaders need to plan for their next chapter of life and families need to identify valued roles for elder family members.
Question the ‘theory of one’
“A generation transition involves a passing of ultimate responsibility for all of the major activities of the family,” Davis said. “This almost always involves passing the leadership of the family company, but families have more interests than just the family company.” Consider philanthropy, the family office, the management of the family’s outside assets, and the leadership of the family itself. At the end of the process, you want a capable and committed next generation successfully leading the family’s key activities.
Many families believe all of these activities can and should be led by one person — the “theory of one.”
“Sometimes this approach works, but it has consequences: It not only saddles one person with wide responsibilities, but often means some family activities will get little attention, and that only business leadership will be valued,” Davis said. “There are better ways for a family to get things done and maintain unity.”
Smart transitions are about having a team of family members (and non-family managers where appropriate) ready to take on different positions and responsibilities in the future.
Prepare the business (and other family organizations) for the transition
Maintaining momentum also means that companies need to be prepared to support and flex with the changes the next generation brings. “That means preparing for new investments in new business opportunities, reconsidering standard management practices, strengthening the company’s balance sheet, adapting the culture of the company, transitioning key customer relationships, and so on,” Davis said. “You want the next team to hit the ground running.”
The new generation of leaders will hopefully want to pursue some different strategic goals and, likely, will manage with a different style. The senior generation and the organization must integrate and facilitate these changes while maintaining important corporate values — without starting a tug of war between entrenched practices and the new vision. “It’s typical for the senior leaders to see some change as threatening, rather than exciting, and for next gens to feel held back,” Davis said. “But transitions go better when the next generation shows appreciation for the accomplishments of the senior generation, and the senior generation appreciates the need to change in healthy ways.”
Build a new ownership team
In a generational transition, ownership is generally passed from a smaller to a larger group of people and a new group of owners must support the business and other activities of the family. According to Davis, ownership should be treated like a job — a strategic tool — but most families spend little time considering who deserves to be an owner and how ownership should be structured. “Families are generally on autopilot regarding the ownership transition,” he said.
Instead, the two generations need to have transparent conversations about how ownership will be exercised, divided, and transitioned. What is the job description for family owners or beneficiaries? Should shares be passed over a 20-year period starting when the next generation of owners is in their 30s? Should ownership be given to individuals based on specific conditions, such as being an employee? What kind of shareholder agreement will best serve the next generation? The right kind of ownership formula will provide a more stable foundation for the business organization and build unity among the succeeding generation. The next generation of owners must not only be well-prepared individually to perform as owners but need to be trained and motivated to coordinate like a team.
Of particular concern are situations where ownership is only passed, or even revealed, when the senior generation dies. “This is dangerous,” Davis said, “and not simply because of estate taxation. When ownership comes all at once, at an emotional time, the next generation is unpracticed as an ownership team.”