Importance of Private and Family Businesses
It has been widely reported that Baby Boomers entering retirement age are expected to transfer $30 trillion in assets to their children and grandchildren over the next several decades. An important part of this is in the form of privately held businesses. According to Forbes, there are roughly 4 million Baby Boomers who own and operate their own companies, representing approximately 66% of all U.S. domestic businesses with employees. Forbes has also reported that many business owners have 80% or more of their personal assets tied up in their businesses and that an estimated $10 trillion in business assets may be transferred by the Boomers by 2025. With the huge dollar amounts involved, it might be reasonable to ask about the track record of private businesses passing to successor generations.
High Failure Rate – Successor Generations
Unfortunately, the record isn’t good. As important as family businesses are to the financial health of individual families and the U.S. economy, they can be fragile entities when passed on to future generations. It has been estimated that only one-third of family businesses survive the transition from the first to the second generation of ownership, and only 12% are viable into the third generation. Given the known high failure rate, it would appear that succession planning would be crucial to these entities; however, this is not the case.
Lack of Succession Plan
Despite this huge expected transition, which includes more than half of all U.S. businesses with employees, fewer than 25% of private company boards have a succession plan in place, according to the National Association of Corporate Directors. Despite the financial importance to their owners, and given the poor track record in passing to the next generation, it should not be surprising that family businesses don’t do much in the way of succession planning. However, this failure rate is not only the result of a lack of planning, it can also be strongly influenced by the choice of successor CEO, and the selection process, or lack of one, which, from decades of personal experience, is another problem area for family businesses.
The Sudden CEO
A “Sudden CEO” is an inexperienced person who takes over the CEO role unexpectedly, often following the death or incapacity of the prior CEO. While death is traumatic for any family, unfortunately, its effects can be compounded if a poor CEO successor is chosen.
Importance of Initial Successor Thoughts
A family’s initial reaction to the successor issue can be crucial because it often leads to a quick decision about the “best available family member” choice, rather than an effort to find the “best-qualified” candidate. When a logical successor is the best available candidate, the business has a much better chance of surviving and prospering. However, when the choice is made from a limited pool of candidates (such as only family members only) and conducted in a hurried manner, the chances of long-term success can be greatly diminished. Why do families rush such important decisions and why do they not always try and find the best candidate, especially when it involves a key part of their financial well-being?
Maintaining Control, Safeguarding Assets
Many families believe that the successor must be another family member, regardless of qualifications. This belief often stems from a perceived need to protect the company’s cash and other valuable assets, i.e., “only family can be trusted to do this.” (This conviction can also contribute to a quick selection process.) While this may be a common perception by families, it isn’t necessarily valid. The family can exercise control over the business and protect its assets and cash through basic business and financial controls and procedures, including with family members serving as check signers and progressing from there. Qualified outsiders, such as accountants or experienced consultants can also assist families in monitoring and running day-to-day activities, allowing time for a more thorough search. Attorneys and insurance professionals can help protect the owners and company through various types of insurance and business agreements.
Assistance from the Formal/Informal Network
When a logical CEO successor doesn’t exist, they can often turn for assistance to their formal or informal network (“Network”) of advisers, accountants, attorneys, company managers, family members, clergy members, family friends, etc. Among the benefits this Network provides are suggestions for dealing with the business in the short term and the names of possible CEO candidates. Even when the Network is unable to quickly identify good candidates, it can still help the family avoid making a poor choice of successor.
One of the best things the Network can do for the family is to help it vet potential candidates. This service can be invaluable especially when, in conjunction with family issues and tensions, unqualified family members are jockeying for the CEO position. In these circumstances, because they are removed from the family dynamic, not only can the Network vet potential candidates (sometimes in formal interviews), but it can also help break the news to unsuitable family members in a more detached manner. Also, if appropriate, instead of finding a new CEO, it may be able to help identify an interim CEO. (See the related discussion further below.)
Avoiding Unqualified Candidates
Families often view themselves as having superior business skills and abilities, even when they aren’t familiar with the company or even business in general. It is also not uncommon for the CEO to be the child or heir who was on the best terms with the CEO when he or she passed. If the business is the largest part, or even an important part of an estate, does it make sense to put it in the hands of an inexperienced person in terms of business experience and ability?
An important question to ask is whether the proposed successor would be in line for the CEO job if not solely for the family connection.
Recognize that the Business is an Investment
Often, people who have an investment manager for their investment (securities) decisions, choose not to use its business counterpart, a business manager or experienced CEO, to assist them with a potentially much more valuable investment, their business. Whether the goal is to grow the business for sale, or for the next generation, a qualified manager or CEO can be vital to the success of a private company. Care should be taken to recognize whether family members have the requisite experience and aptitude as well as time to devote to the business.
While the family adjusts to the loss of the departed CEO and the candidate evaluation process gets underway, one way to take pressure off the family is to consider appointing an interim CEO. Usually, this person fills the CEO role until a permanent replacement is found. This can be a great way to allow the family sufficient time to deal with family issues, while not leaving the business in a bind. Typically, interim CEOs maintain the status quo as opposed to embarking on new company initiatives such as developing new services and products. Depending on the circumstances, sometimes this role can be temporarily filled by a trusted friend, adviser, or family member, who is authorized to sign/approve checks and payroll, interact with the employees, and make basic, day-to-day business decisions.
Finding a Replacement CEO
The goal of identifying quality candidates to be considered for the CEO job is not a one-size-fits-all proposition. It can involve the assistance of the Network, professional recruiters, bankers, industry contacts, etc. Ideas can also come from LinkedIn and other social media platforms.
Sometimes the best candidate already works for the company. Other times, prior employees are brought back because of their knowledge of the company and industry. Existing employees can even be partially elevated, such as to a VP or COO position, to help maintain business continuity and assist the eventual CEO. Industry friends can also make helpful recommendations, as can recruiters, especially those who specialize in particular industries.
Once identified, candidates can be interviewed by the Network or others. Hybrid arrangements can be utilized as well. For instance, a professional recruiter can be employed to interview top candidates and issue recommendations to the family. Regardless of who performs the interviews, the process shouldn’t be needlessly rushed. Arbitrary deadlines, especially when established by people unfamiliar with the interviewing process, can result in bad outcomes.
While the loss of a CEO can be very traumatic, it is especially so for a private family-owned business lacking a CEO succession plan. Not only must the family contend with its grief over the loss of its loved one, but it must also keep the business going and appoint a new CEO. Although these circumstances make for a less than ideal decision-making environment, given the importance of the business to the family, it must act. This is where its formal/informal network of advisors, accountants, attorneys, company managers, family members, clergy members, family friends, etc., can play an important role in helping the family to select a new CEO or an interim CEO, and above all, help it to avoid defaulting to a “Sudden CEO.”
James F. Hart, MBA, CPA, CIRA, founder of Lightfoot Group, LLC, assists business owners and their key advisers with business troubleshooting services involving critical business challenges, dispute resolution, and management and ownership transitions. Jim has decades of experience as a court-appointed receiver, business advisor, and interim manager including operating and selling companies and assets, resolving disputes, and assisting family-owned businesses.
© 2018 James F. Hart, Lightfoot Group, LLC
 Forbes, Why Small Businesses Are Feeling Economic Crunch, October 11, 2015: https://www.forbes.com/sites/brentbeshore/2015/10/11/the-small-business-crunch/#5c5b9b25b498
 Family Business Institute: https://www.familybusinessinstitute.com/consulting/succession-planning/
 Forbes, Why Small Businesses Are Feeling Economic Crunch
 The family should have a clear understanding of the terms of the will as it relates to the business. This is not the time for DIY legal help.
 Conversely, the Network can help identify and shepherd a qualified family member into the successor role.