Business Succession Planning In Family Businesses

Introduction 

Effective business succession planning is critical for ensuring the continuity and long-term success of an organization. This particularly rings true for family businesses, where the transition of leadership from one generation to the next can be a sensitive and complex process. In this article, we shall introduce the concept of business succession planning, explore why some family businesses tend to avoid it and discuss the key factors to consider when developing an effective  succession plan. 

What is business succession planning? 

Business Succession Planning is the process of identifying and developing talent within or outside of the business to replace owners or key employees when they have transitioned into a new position or exited the business.  

Succession planning in family business 

Turnovers can significantly affect a business, often leading to disruptions and instability. Notably, succession planning is often more straightforward in non-family businesses, where top management can retire without extensive concerns about finding their replacements. In contrast, the survival of a family business heavily depends on careful planning for the transfer of ownership and leadership to the next generation. 

In Kenya, the majority of businesses are family-owned or controlled. Statistics however reveal a sobering reality; only approximately 30% of family businesses survive into the second generation and majority of family businesses are dissolved before reaching the third generation. This is often due to the lack of a well-formulated and implemented succession plan. In fact, many family businesses either put off the succession planning of their owners and top managers until the last minute or avoid it entirely. Common reasons for this may be: 

1. The family wishes to avoid conflict or indecisiveness in instances where several potential owners/successors or top managers are available within the family; 
2. The family wishes to avoid the highly emotive and uncomfortable discussion of eventual loss of a family leader; 
3. The perception that no family member or outsider is capable of replacing the current owner or top management; or 
4. The current owners or top management refuse to admit the business can survive without them. 

While these reasons for avoiding succession planning are understandable, the benefits of embracing it are far more compelling. Succession planning ensures continuity, preserves the family legacy and mitigates the risks associated with abrupt leadership changes. 

When creating a succession plan, the following factors should be considered: 

1. The business structure- in certain business structures, such as sole proprietorships and partnerships, there is no distinction between personal and business assets, as the business lack its own legal identity. Consequently, the owner cannot bequeath the business in a Will or pass it on to the next generation after their death. To ensure the business continues to exist, it is advisable to incorporate a company which enjoys perpetual succession. 
2. Distinction between ownership and management- family business can be owned by family members (shareholders) while being managed by non-family professionals (directors, managers etc.). It is therefore important to have separate succession plans for ownership and management. Ownership succession plans focus on transferring ownership and control of the business to the next generation whereas management succession plans focus on ensuring smooth transition of the business by identifying future leaders. 
3. Trust- trust is a key aspect in succession planning in family businesses. The predecessors and successors in ownership and management positions should have a mutual trust amongst each other and have an understanding of the strong family values and culture, in order to have an effective succession plan.  
4. Written vs oral succession plan- some family businesses have an oral succession plan or unspoken rule on who will take over the ownership or management of the company, however this is bound to cause uncertainty or conflict within the business. Consequently, the transfer of ownership and control of the business to the next generation becomes increasingly difficult as the family size increases. Therefore, it is advisable to have a formal written succession plan to ensure clarity and avoid disputes.   
5. Tax efficiency- The succession plan should be designed to be tax efficient for both the outgoing and incoming owners/managements. This helps in minimizing tax liabilities and preserving the business’s financial health. 
6. Seek advice- the succession process is only complete when the successor is widely accepted by the stakeholders. Consulting external independent directors, top non-family managers and family members when selecting potential successors can provide valuable insights and ensure broad acceptance. 
7. Diligence- identifying and preparing successors to take over and manage a business is not a spontaneous task, it can be a multi-year process requiring careful consideration. A succession plan should be regularly updated to reflect current business conditions and ensure its continued relevance. 

Conclusion: 

Business succession planning is an essential process for ensuring the longevity and stability of family businesses. A solid succession plan can drive business growth, set the stage for a smooth retirement transition and reduce tax liabilities. It is advisable to engage a qualified lawyer to assist your business come up with a legally sound succession plan that not only secures the future of the business but also strengthens the family’s commitment to their shared enterprise.  

How can we help? 

At CM Advocates LLP, we have an outstanding team of Wealth and Private Client lawyers with a wealth of experience in matters relating family businesses, succession planning, wealth management, marriage, divorce, children custody and maintenance, estate planning, and trust administration, spanning across the East African Region. We welcome you to take advantage of our team of experts and consult on these critical family business issues and learn how to formulate and implement succession plans to aid in the sustainability of your family business. 

Should you have any questions regarding the above legal alert, or related topic, please do not hesitate to contact  us on law@cmadvocates.com or mmachua@cmadvocates.com 

Contact Persons & Contributors 

Melissa Machua- Senior Associate