Generational succession—handing your business over to your kids or family—sounds simple enough, but many families end up in a dispute right when the parents, business, and children are most vulnerable. To avoid misunderstandings and disputes, generational succession must be managed as closely and diligently as if you were selling your business to a stranger.

If you are looking to hand your business to your children or relatives, there are a few key issues to think about:

Capability and willingness of the next generation – do your kids really want the business?

It’s crucial to realistically assess the business’s potential for success after the transition. The exit-ing generation may aim for generational succession to maintain the business within the family, uphold their legacy, or ensure a stable future for the next generation. These are all valid goals, but they can only be achieved if the next generation has the necessary capability and willingness.

An alternative scenario can also exist where the younger generation pursues generational succession. In some cases, it’s seen as their birthright. In these cases, the willingness will exist, but this does not automatically translate to capability.

Capital transfer – how much money needs to be taken out of the business during the transition?

Understanding the level of capital needed during the transition is crucial. What level of capital do the current business owners, generally the parents exiting the business, need to extract from the business at the time of the transition? The higher the level of capital required, the greater the pressure that will be placed on the business and the equity stakeholders. This understanding empowers you with the knowledge to make informed decisions and prepares you for the potential challenges of the capital transfer process.

In most cases, the incoming generation will not have sufficient capital to buy out the exiting generation. This will require the vendors to maintain a continuing investment in the business or for the business to take on an increased level of debt.

In many cases, the exiting generation will want to maintain a level of equity investment. This might be a means of retaining an interest in the business or alternatively staging their transition. In either case, no generational transition should be undertaken without a clear and agreed capital program. This program, which needs to be documented and signed off firstly from the business’s perspective and then by both generational groups, is a key element in ensuring a smooth and secure transition.

Income needs – ensuring remuneration is on commercial terms

In many SMEs, the owners arrange their remuneration from the business to meet their needs rather than being reasonable compensation for the roles undertaken. This can result in the business either paying too much or too little.
Under a generational succession, there should be increased formality around compensation to directors and shareholders. Compensation should be matched to roles, and where performance incentives exist, these should be clearly structured.
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Operating and management control

Once the capability and capital assessments have been completed, it is essential to look at the transition of control. This can be a very sensitive area. It’s critical to establish and agree in advance on how operating and management control will be maintained and transitioned. Your input and decisions in this process are crucial.

The plan for operating and management control should be documented and signed off by all parties. It should include either timelines for time-driven succession or milestones for event-focused transitions.

Transition timeframes and expectations

Generational succession is often a process rather than an event and is achieved over an extended period. The critical issue is to identify and ensure that all parties have a shared understanding and acceptance of the time period in which the transition will take place. This should be included in the documented succession plan.

The need for greater formality and management structure

Generational succession often requires a greater level of formality in the management and decision-making process. This formality should achieve a separation of function between management, the Board, and shareholders.

Often, in an SME business, these roles merge, and there are no clear dividing lines or boundaries. Roles, responsibilities, and clear key performance indicators (KPIs) for management should be agreed upon and documented.

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