Three Key Words That Help Explain the Family Business Succession Conundrum

Over the past four decades, family businesses in China---which had disappeared entirely---have reemerged and thrived with the enormous business opportunities presented by China’s reform and opening-up. Though few great family businesses have appeared, the notion of the family business has become part of the popular consciousness. Now that the founders of many such businesses are approaching retirement age, what problems and challenges will their companies face in the process of intergenerational succession? 

Family businesses in China began developing much later than their counterparts in Europe and the United States and even fell behind those of Hong Kong, Taiwan, and other economies in Southeast Asia. Whereas family businesses in other countries have survived four or five generations and reached the developmental stage of professional governance, most Chinese family businesses haven’t yet overcome two major pain points. One is related to succession, especially the succession from the founding generation to the second generation. Chinese family businesses, for the first time, are faced with the handover of power, changes in leadership and management style, and the transition (and even division) of family wealth. The other pain point concerns corporate transformation. Due to the economic characteristics of China’s reform and opening-up, previously fast-growing traditional industries are no longer in an advantageous position. As a result, family businesses are left struggling between transformation and succession.

Pain Point I: succession by second-generation family members?

Chinese family businesses have encountered the same pain point as their foreign counterparts in the process of succession---should the baton be passed onto the second-generation family members? Since the succession process often involves high complexity, it needs to be planned and controlled in an orderly way. Every step taken, from succession planning to the distribution of ownership and involvement of professional management, can play a make-or-break role.

According to the psychologist Lansberg, most parents naturally want their offspring to inherit the family businesses they founded as a way for their hopes and dreams to live on to from generation to generation. But the younger generation is offered infinite possibilities built upon the elder generation’s success. For these younger professionals, taking over the family business is merely one of many career options.

However, traditional Chinese culture puts a premium on the clan, the family and family ethics, which is evidenced by the long-established hereditary system that survived through the feudal dynasties and has been preserved by many modern family businesses. Therefore, most family business founders tend to follow patrilineal succession out of both emotional considerations and real-world circumstances.

Bringing in professional managers is not easy for family business owners. The failure rate for family businesses run by professional managers may be much higher than for those run by second-generation family members. Ultimately, the succession process is actually the transition of ownership and control; unfortunately, we can hardly find any clearly defined boundaries between these two terms in China.

Professional managers face the challenge of becoming real members of the family business. Whether they can accept the emotional dynamics and values advocated by the family will directly influence their performance and commitment to the family business. In a family business involving complicated relationships, a professional manager’s “outsider” status can be a double-edged sword.

To evolve from “outsiders” to “insiders” and be trusted with management authority, professional managers have to prove their management abilities, wisdom and moral values. In the meantime, family business founders must be patient and open-minded, and work out careful succession plans. It is a long and complex process.

Deciding whether to adopt professional management remains a delicate matter for the moment. The management excellence of professional managers may shield a family business from the damage of internal conflict, but whether they feel a deep attachment to the company is still a big concern for the family business owners. Without a sense of family mission, the “outsiders” are more likely to abuse the family’s fortune or influence to line their own pockets and benefit at the company’s expense.

Furthermore, at family-run companies, the effectiveness of professional managers is generally measured via an array of performance indicators. Even when certain equity incentives are adopted, professional managers are often tempted to chase fast growth in the short term despite damage to the company’s prospects in the long term. Therefore, Chinese family businesses face a dilemma: the rich second generation are not strongly motivated or competent enough to take over the companies, while the professional managers are not totally devoted to the companies.

Pain Point II: the Transformation dilemma

Another pain point is strategic corporate transformation. Transformation can be a challenge for any company. But when a family business is involved, there are some additional quirks to deal with. First of all, as the succession issue is further complicated by the urgent need for corporate transformation, the family business founders may find it harder to confidently hand the baton to their successors. Some founders may become even more cautious, making the succession process more difficult. Admittedly, many more founders are open-minded enough to embrace the transformation. But what measures should they take? The approach to this issue makes a huge difference.

When China launched its open door reforms and entered the market economy, its open markets gave birth to immense entrepreneurial opportunities in various sectors and as a result, family businesses began to spring up across the country. However, restricted by the overall economic structure, most family businesses were in the low-tech and labor-intensive industries, especially the low-end manufacturing industry. Those that managed to thrive over the past four decades have built up substantial corporate assets, accumulated considerable family wealth, and realized multi-fold expansion.

Nevertheless, it should be noted that as market opens fully and international competition increases, the transformation and upgrading of companies become inevitable. To survive in the Internet era, companies have to accomplish the strategic transformation from the low end to the high end. Many labor-intensive companies must be restructured so as to secure their position in the fast-growing market. More concretely, the soaring cost of labor will drive companies to reform production models and produce bigger economic benefits with more effective and economical approaches. Therefore, in the process of transformation, family businesses need to leverage resources and opportunities to boost growth. To this end, transformation is of great significance to the development and succession of family businesses.

Chinese family businesses have been exploring and struggling with how to resolve these two pain points. Guiding a business during succession may be a more challenging task than founding one, and the intergenerational transfer of power seems to be the most vulnerable part in the process of succession. The succession, if mishandled, may become a boom-to-bust turning point for a family-run company and even weaken the family’s control over the company.

Inheriting a strong sense of Responsibility

China’s one-child policy has created a large number of one-child families. This presents a special challenge to family businesses approaching the stage of succession. Many first-generation entrepreneurs worry that their only daughters or sons are reluctant or unequipped to take up the helm, and that their years of efforts will have been for nothing. While facing a limited selection of successors, the first-generation entrepreneurs have to take into account their offspring’s personal interests, abilities and attitude toward succession, so as to work out effective succession plans without putting their companies in peril.

First-generation entrepreneurs cannot wait until retirement age to start deploying a succession plan. In fact, it takes at least 10-15 years to nurture a competent successor. Therefore, a family business should put succession planning on the agenda much earlier. To grow into an entrepreneur, a person should prove himself/herself to be willing and able to run a company. In addition, there has to be the right fit. In the case of family businesses, the possession of family wealth doesn’t necessarily mean there are always such opportunities for the second generation. The opportunity for corporate transformation, in particular, can either help or hurt the development of family businesses.

Unlike the first generation, who had no choice but to embrace the family business as a lifeline, the second generation is taking up the baton out of a strong sense of responsibility. As only children due to China’s one-child policy, the young successors regard it as an unshakable duty to carry forward the family business, which also reflects their blood ties and their identification with family values. They have witnessed the elder generation’s hard work and business savvy since their childhood, and hence have developed a strong identification with their families and the courage to take the reins.

If they choose to take over their family businesses, members of the second generation set aside a worry-free life and their personal interests. Most of the second generation have received education overseas, and they do not show a strong interest in the traditional industries where their family businesses have been operating. Instead, feeling the pressure for corporate upgrading and transformation in the family business, and the lure of quick money, many of them are more inclined to make inroads into the financial investment sector or set up their own businesses.

Compared with their elders, the second generation in mainland China show greater reluctance to take over the family business because of intergenerational differences in values, the fast changing economic landscape and a downhill trend in the businesses founded by the first generation. While enjoying the material conveniences created by the first generation, the rich second generation boast strong learning abilities, social adaptability and business acumen, and are highly receptive to new things. Having witnessed China’s robust economic growth and having been exposed to the advanced management philosophy of the Western world, the second generation are strongly averse to traditional industries and rules. The first- and second-generation entrepreneurs are quite different from each other in terms of the environment they grew up in, educational background, and the opportunities and challenges facing them.

Therefore they have developed different thought patterns and views of the world and life, as well as different values. When family and business get intertwined, friction between the two generations may harm both corporate development and family cohesion. To this end, it must be out of a strong sense of family responsibility that the second generation decide to take over from the first generation despite all these difficulties and challenges. Excellent second-generation entrepreneurs, with their innate and acquired sense of responsibility, are becoming a major driving force for social transformation and corporate reform.

As for the succession issue, the first-generation entrepreneurs need to set aside more time for self-reflection rather than continually raise their requirements for the younger generation. Have they often prioritized their careers above their families, and hence caused their children to lack a sense of family responsibility? Have they been too domineering? Have they already introduced standardized management and avoided creating roadblocks for the younger generation to develop their personal talents? The mentality and behavior of the second generation often mirror the values and behavior of the first generation. When facing obstacles in the process of succession, the first generation may benefit from looking inward as a way to find the fundamental cause of the problem.

Succession doesn’t simply mean passing the baton on to the next generation; more important are establishing systems and passing the corporate culture on. Instilling good values and teaching by example are critical to their success.

(Author: Jean Lee, Director of CEIBS Centre for Family Heritage; Rachel Lu, Assistant Project Manager)
(Fortune Generation, April 2016)