Succession Issues In Family-Run Companies — How to Deal With Them

In the past, we have witnessed succession issues even amongst kings. For example, we have seen diametrically opposite succession issues in our epics Ramayana and Mahabharata.

Majority of the private sector listed companies in India are family-owned and family-run companies.

According to an  empirical  study conducted in 2008, in India, there were 224 billion $ listed companies accounting for 81% of the total market cap of all the companies listed on the Bombay Stock Exchange (BSE). Further, the promoters’ stake in those billion-dollar companies was 67% of the total market cap of those companies. Moreover, only about six companies (ICICI Bank, L&T, HDFC, IDFC, ITC and IFCI) have no identifiable individual promoter or promoter group.

(Source: Building Billion $ Indian Companies by Market Cap, by Dr. Pravin P. Shah, Growth Publishers, 2008)
 
Worldwide, majority of the businesses in number as well as in value are family-run and family-managed. Hence, the succession issues are a global phenomenon.

In India, we have witnessed that wealth does not pass in the family beyond the third or fourth generation or business does not remain with the family beyond the third or fourth generation. One of the main reasons for this is that the succession issues are not properly managed.

To illustrate various issues and challenges involved in succession management, various  real-life examples are given at appropriate places. The purpose is not to criticise any particular person, group or family, but to learn from the way they handled succession issues and/or their mistakes.

In this article, masculine pronouns are used for brevity and refer to both males and females. Hence, ‘he’ also means ‘she’ and vice versa.

Can succession be managed?
The basic question is can you manage succession, just as you manage a project or a business?

Yes, it is possible to manage succession, just as managing a project or a business. The basic principles are the same. In  Kautilya’s Arthashastra, Rajguru Chanakya explains how the succession in the kingdom from generation to generation should be handled.

Let us discuss some of the important ingredients of effective succession management in family-run companies and how to achieve them.

Step-1: Awareness and recognition
The present leader should recognise the reality and be aware of various events which are likely to happen, such as the following:

•     Some day, he will have to retire and somebody will have to succeed him.

•     He should recognise that succession can be managed and if he approaches the issues systematically, he can implement succession more effectively and smoothly.

•     Succession management requires long-term planning and execution: there are no quick-fix solutions. For example, it has been reported that Captain Nair, Chairman of the Leela Group of Hotels has decided a succession plan to avoid any family feud in the future. According to his plan, his elder son, who looks after finance and day-to-day operations will get the hotel business while his sibling will spearhead the group’s new ventures.

•     A leader should also be aware that sudden emergency may arise because of his untimely death or severe disability.

•    In Succession management, things may not happen as planned. However, if the succession is systematically managed, then the outcome would be much better than if it is handled haphazardly.

Step-2: Define vision–mission–goals for succession management

It is essential for the present leader to define his vision, mission and then set the goals. For example, his mission statement could be: “Have a smooth and effective succession consistent with the family values and harmony”.

Step-3: Understand pre-requisites for effective succession management

Following are the major pre-requisites for effective succession management:

•    The leaders should take care of all the members of the family.

•     He should have a proper mindset and provide appropriate opportunity and wealth to every member of the family.

•    There must be fairness in his handling of succession management.

Step-4: Understand what influences succession decisions

A leader should learn the factors which may influence the effective and smooth succession management and decisions. Some of them are summarised below:

•    Emotional vs. Rational Thinking: e.g., my children should succeed me whether they have merits or not.

•     The family often thinks that a well-established family business can be run successfully by anyone in the family.

•    The family members may have an incorrect perception/view about the capabilities of the next generation, even though it may not be in tune with the reality. For example, the parents may think that their child is very capable of being a successor to the present leader.

Culture, personal value systems and family tradition: For example, elder son always succeeds the father.

•     Ego Trip: The outside perception by relatives, friends, and executives in the organisation, etc. For example, if an elder son is not given a responsible position in the organisation and the younger one is given a responsible position or a better title, then it may be a subject-matter of gossip, evaluation, criti-cism.

•     The thinking regarding females: Whether females can work in the family companies and can females succeed to a family business?

A problem would arise if the female members do not agree to the thinking that they cannot work in the family companies or they cannot succeed to the family businesses.

Step-5: Identify succession challenges/issues

In India, we are witnessing the succession issues in more and more family-run companies, such as Birla, Tata, Bajaj and Reliance, and even in a professionally-run company like ICICI.

For example, in the Birla group, Mr. G. D. Birla was succeeded by his grandson Mr. Aditya Birla, bypassing his father.

In the Bajaj family, because the brothers, sons and cousins are contenders, there are succession disputes among them.

In the Tata group, presently the successor-Chairman is being selected, who may or may not be from the Tata family.

The present leader should identify the challenges that he is likely to face in effective succession management. For this purpose, he should proceed systematically. He should list out the family members, their present ages, and the likely major future events and their timings, e.g., children’s education and training, their entry in the family business, his retirement and the succession. Based on this, he should prepare a list of likely succession challenges he will face in years to come.

One of the major problems in a family-run company is to decide about the succession criteria. For example, whether the succession should be based on merits or on seniority.

Hence, every family should define the family values and the personal values system it wants to follow in this respect. This requires tough decisions on the part of the family, particularly, in a family-run listed company.

If there is only one potential successor, the question may be about his present capability, his potential to be a leader, his age, his will-ingness, etc.

Sometimes, a potential successor is capable of succeeding, but he may not be interested in the family business and he may want to set up his own business or profession. The present business may not measure up to his ambitions and aspirations. Post liberalisation and globalisation of the Indian economy, a vast number of opportunities have opened up for starting new businesses.

Further, a potential successor may not be interested in being in any business; he may want to be a doctor or a professor or a social activist.

Let us suppose that the father wants to retire in one or two years, and therefore, the succession question has arisen.

Let us further suppose that he has one son who is actively involved in the management of some of the companies in the group. He is capable of succeeding the father, but he is not ready to take over the full rein of the group because he is not willing to devote full time and attention required for managing the business.

If an outside person is brought in as a CEO, then the question of working relations between the son and the outside CEO would arise.

In several wealthy families, it is witnessed that some children do not have a fire in their belly or they just want to enjoy life with the family wealth.

The potential successor may have the technical competence, but he may not have leadership quality or skills which may also be very important for a particular business.

In a knowledge-based business, the potential successor may not have the required knowledge as well as skills and he may not be willing to acquire the same. That would really pose a challenge because a person cannot manage or control a function which he cannot himself do.

The problem is more complex in a knowledge-based service company (e.g., financial services, IT software, etc.) than in a manufacturing company.

In some cases, where the present leader is relatively young or is not likely to, or willing to, give up his rein in a timely manner, then also there may be a conflict with the potential successor even if there is a single successor. He may not be willing to wait for a longer time required for succession.

In such cases, one solution may be that the existing leader gradually delegates more and more responsibilities to the potential successor, so that the potential successor is able to do worthwhile work commensurate with his abilities.

If the potential successor does not have the capability as well as potential, but the promoter insists that his family member should be a successor, then it may adversely affect the functioning of the company.

If the son (or daughter) of the promoter has no capability at present, but has the potential to succeed, and if he takes over the reins today, then he may become diffident or he may not be able to properly manage the company.

If in a family, there is more than one contender for succession, then also there may be a problem. E.g., brothers, uncle and nephew, cousins, son and nephew may be contenders in which case the conflict may arise (e.g., Bajaj family). Further, if an elder brother is less capable than a younger brother, the problem of selecting the successor may be a vexed issue.

If a successor is very much younger to the top one or two senior executives, there may be an issue of whether the younger promoter would be able to lead very senior executives.

The management style of the present leader and the potential successor may be diametrically opposite. Therefore, he may not be interested in working under him or following his footsteps. This may create a potential conflict between them.

Several families have decided that the equity shares held in the listed company will pass on only to the male members, and the female members will get the wealth in monetary terms. This raises several vexed issues. For example, how to monetize the shares in the family-controlled listed company to give the monetary value to the female members in the family? When should this be done? What if at the time of inheritance, the other male members in the family do not have adequate liquidity to buy the shares from the female members who will inherit the same?

Succession issues are there even in a professional firm of chartered accountants and lawyers. However, in a partnership concern the issues involved are different from those in a limited company because in a partnership concern there may not be hierarchy of positions.

Step – 6 : Develop appropriate solutions to challenges

One should develop appropriate solution(s) for each issue. It may not be possible to develop a solution immediately. But one should periodically think of the solutions, may be with the help of others.

If there are two possible contenders, then both may be given a title of joint managing director and then a division of functional responsibilities be made between them according to their capabilities.

Real-life examples: Some real-life examples will illustrate the point.

Real-life example-1

Facts

Some 20 years ago, a promoter of an unlisted software company recognised that he has 2 sons studying in a college and one day they may enter his business. At that time, succession issues may arise, and therefore, he wanted to plan in advance. For that purpose, he decided to start another business in the same line which would gradually become of equal value.

He also wanted that during his active life, he should have the final say in respect of both the businesses. Once his sons become capable, he would gradually give the responsibilities to them. He wanted that the succession should be very smooth and tax-efficient.

Issues

•     The first issue involved in this case was of the ownership, present ownership and passing of the ownership to the next generation.

•    The second issue involved was of the present management control and gradual passing of the control to the next generation. The control in legal sense arises from the ownership of the equity shares and if the ownership is to be passed on to the next generation during the lifetime of the present leader, then the tax issues may arise because at that time gift tax was in force.

Solution

An appropriate solution which would meet his requirements from a taxation angle as well from a business angle was developed by his chartered accountant. This demonstrates the role a chartered accountant can play in the succession planning.

Outcome

Today, his both the sons are involved in managing two different businesses which have synergies, but each one is running the business independently. This has avoided the potential conflict between the father and his two sons which could have arisen if there was a single business.

Similarly,  it  is  also  reported  that  the  RPG Group has divided its companies between the two brothers.

Real-life example-2

Compare this with the case of Dhirubhai Ambani Group where RIL is the company and there are two contenders to succession, Mukesh and Anil. Everyone is well aware about the legal battle which was fought between the two brothers regarding the succession and division of the RIL businesses, their assets and related issues.

Should succession be to the same business?

•     The first objective should be the preservation of the wealth in the family and the second objective should, if possible, be the preservation of the same business in the family.

•     If the next generation is not interested in the same business, the succession need not be to the same business. In such a case, the existing leader should provide support in developing the business of the choice of the potential successor, and at appropriate time sell the existing business.

•     An interesting case of succession is of two sons of Dr. Parvinder Singh who inherited Ranbaxy Laboratories Limited and later on sold it to Daiichi of Japan. With that money, they have started new businesses in the field of financial services (Fortis Financial and Religare Financial Services) and healthcare (Fortis Hospitals).

Is it possible to separate ownership and management: In India, it is very uncommon. But in developed countries, it is very common.

Step-7: Have code of family governance

In a family-run company, the succession management, governance of the company and governance of the family go hand in hand. Hence, every wealthy family should have a code of family governance or family code of conduct and preferably, it should be in writing. Examples of corporate houses which have adopted such a code, include, GMR, Lanco, etc.

The family code of conduct should cover division of assets/businesses amongst the family members, rules for business decisions, succession criteria, training and grooming of the family members to a defined carrier path, inheritance, separation from the family, misconduct, etc.

The code should also cover all other major aspects, such as code of conduct in public, various decision-making rules, remuneration policy for family members, the personal lifestyle related issues, such as residence, type and number of cars each member could have, club membership, etc.

Every family member should be required to read and understand them. There should be a characteristic approach. Those who follow the family code of conduct should be appropriately rewarded and those who do not follow it should be appropriately punished.

Step-8: Is it possible to develop entrepreneurs/ leaders?

It is often debated whether it is possible to develop entrepreneurs or leaders, or are they born and not made? The answer is Yes and No.

It is not possible to develop or train a person to be an entrepreneur or a leader to deal with every aspect. However, there are a number of areas where he could be given proper and appropriate education and training to make him a better entrepreneur and leader.

Secondly, it is not a question whether it is doable or not because in a family-run company if a successor has to be from the family, then it is essential that he is given proper education in this respect, so that his chances as a successful leader are improved.

Step-9: Build capability of potential successors: train and groom

It is very important to groom the potential successor for taking over the rein when the existing leader would retire. This requires proper education and training of the potential successor. The potential successor should not assume that because he is from the promoter family, he has a birth-right to succeed or that he can manage the family-run business.

For effective succession management, efforts must be made on building the capability of every potential successor. The capability-building exercise should begin from home and right from the childhood.

Every child in the family must be given basic education and appropriate higher education. Nowadays, recognising the need for this aspect, many management colleges have Family-Business Management courses.

Besides the formal college education, the potential successor should be properly trained and groomed in being a next generation leader.

The training and grooming should be not only at the Board level. He should be given a thorough training in all the key result areas of the business, though eventually he may select one or more of those areas for him to play a major role in years to come.

Step-10: Determine suitability of potential successors: match-making

A potential successor would have certain skill sets and knowledge base. He would also have his likes/dislikes and his ambitions/inspirations.

Moreover, his present strengths and weaknesses should be identified.

Similarly, every business has Key Result Areas or Critical Success Factors for being successful in that business. Hence, it is necessary to compare the Key Result Areas of the family business and compare them with the knowledge and skill sets and the likes and dislikes of a potential successor.

Thereafter, identify the gap and determine whether it is possible and if yes, how to bridge the gap.

In one company, we suggested that the group should set up a separate unlisted company for those members in the family whose background and skill sets were not appropriate for the listed company’s business. These family members are allowed to run the business of that company independently, so that they do not adversely affect the business or activities of the listed company. This recommendation has worked very well with that group.

Step-11: Involve independent directors/mentors/ consultants

The leader should keep in mind that many times an outsider can play a better role as a mentor for the next generation than he himself can. The mentor(s) may be an independent director, close relative, family friend or a consultant.

The mentor(s) should be carefully selected. He should act in an impartial, unbiased and objective manner. He may act as the situation demands, e.g., as a guide, a mediator, provide assistance in objective analysis of the issues, alternatives and their consequences, an arbitrator, etc.

In a listed company, independent directors should ensure that there is a proper succession planning and execution, particularly, where the present leader is approaching retirement or is not keeping good health.

If in case of a listed company, there are several contenders from the family for succession, then ideally the Board or its committee should make the final selection of the successor.

Step-12: Periodical review and revision

Succession management is not a one-time exercise; it is a life-long journey. The decisions taken in the past may require a change or the actions taken in the past may not work out, and therefore, changes may be required in the past succession planning.

Further, if there is an untimely death of the leader, or if he develops some health problem, then a change in the succession timing may required. For example, Mr. Ashok Birla died in an accident at a relatively young age, and therefore, his son Yash Birla had to succeed him at a much younger age.

An annual review of the performance of the key family members should be conducted which will also make the potential successor(s) aware about his (their) progress. For this purpose, the group should establish the evaluation process and the specific criteria.

Step-13: Decide entry and exit timing

One of the important aspects of effective succession is to determine the timing of retirement of the present leader and succession of the successor.

The succession timing should be well planned: it should not be too abrupt so as to leave a vacuum during the transition phase or too late to de-motivate the potential successor.

The potential successor should enter the family-run business as soon as possible. The leader should gradually delegate more and more responsibilities so that the appropriate opportunities are provided to the next generation for taking up the baton.

The present promoter-in-charge may continue as a mentor (e.g., as a non-executive chairman) for a few years until the successor is fully ready to take over the reins of the company. For example, Mr. Narayan Murthy at Infosys did so for a few years. Thus, the practice of having separate persons as CEO and chairman may be followed.

What role can chartered accountants play?

For most family-run companies, particularly small and medium enterprises, chartered accountants are the first point of contact for any issue. At minimum, a chartered accountant can play the following roles:

•     He can draw the attention of the present promoter-leader about the need for succession management.

•     He can list out for him the tough decisions required for succession management and assist him in reaching those decisions wherever he could.

•    He could also suggest the relevant business consultant or the relevant business management courses, which could help the leader and the successor.

•     Any effective success management may involve restructuring of the ownership or the businesses. In this area, a chartered accountant can play a significant role in working out the most tax-efficient and legally effective methods.

Epilogue

A good and effective succession management is achieved through a judicious combination of various factors, such as planning, structure, discipline, mindset, culture, determination, training, implementation, and the like.

Succession management involves ethical and moral issues rather than legal issues. Hence, the approach to this aspect would vary from family to family depending upon its concepts, views and value systems.

Proper succession management, like many other projects, requires thinking and, as Henry Ford put it, “Thinking is the hardest thing there is and that is why very few engage in it”.