Secrets of Successful CEO Succession in Family Businesses

Family businesses are vital to the world economy. Together with Nike, Chanel and Samsung, Roche has made its way to the U.S. $100 billion club. Founded as a small producer of cough syrup by Fritz Hofmann-La Roche more than a century ago, it has grown into a major global player that has developed some of the world’s best cancer drugs. Today, family members remain the majority shareholder of this pharmaceutical giant.

CEO succession is particularly complicated for family businesses. Our interviews with 25 chairmen and CEOs of large family businesses revealed a variety of attitudes and approaches as they face the challenge of choosing their next leader. Some of these differences are accounted for by the size and complexity of the family, the involvement of the family council, what the family charter may or may not say clearly about succession planning, and the extent of leadership talent among family members and within the business as a whole. Other differences relate to the board’s capacity and the readiness to handle the succession process. Based on these discussions, we offer some practical advice on succession planning in family businesses.

The board has the final say

Appointing the next CEO for a family business is no easy task. For succession plans to go smoothly, first there must be a clear definition of the board’s roles and responsibilities.

The primary responsibility of the chairman is to reach a consensus among family members and manage their expectations for the next CEO. Every family member ought to be informed of the decision, and measures should be taken to prevent interference in the process by dissenters.

Lee Man Tat, the third-generation heir and chairman of Lee Kum Kee, a time-honored food company, calls for separation of management and ownership. As he put it, a clear distinction needs to be ensured among family members, directors, managers and shareholders. In this case, corporate activities can be regulated without compromising family ownership, and business operations are shielded from the fallout from family discord.

Supervisory structures and decision-making mechanisms are no less important to CEO appointment. Our research shows that in the most successful cases, the board typically keeps the following in mind when overseeing the succession process:

1. A transparent governance model should ensure a clear separation of roles between the board, family council and CEO.
2. The family charter should set out guidance, if not rules, for CEO succession planning.
3. An independent director can share his/her input from an outsider’s perspective. The best independent director can help identify candidates, objectively judge the board’s decisions, and play a balancing role when the CEO is a family member. Some boards are keen to hire an independent external consultant, who neither parrots what others say, nor balks at asking what others might deem sensitive.
4. The board should orchestrate the succession planning process, laying down rigorous rules for when a stakeholder may get involved.
5. The nomination or selection committee should exhaustively, instead of randomly, review possible plans or proposals on a real-time basis.
6. Candidates should be placed under strict assessment, spanning relevant experience, past performance, development needs and potential, and cultural fit. Such an assessment should be conducted by a third party using the most advanced approaches.
7. A definite CEO tenure shall be set based on the ever-changing expectation of the role. It also provides a clear signal that there is no ceiling for career advancement to the top.

Internal vs. external hiring

One chair cautioned: “CEO succession is far too important and complex to be left to guesswork. Conducting a successful CEO succession program takes time and includes a complex list of activities. Even if all these things are in place, there is still no guarantee of success in appointing the right person."

One of the biggest concerns that family businesses have is how big the prospect pool should be for the next CEO. Our research finds that family businesses that go back three or more generations can be divided into four types, according to their principle of CEO succession.

Type A: CEO must be a family member. This type of company is in a better position to maintain continuity of management, as its managers and owners tend to be the same people or those with close ties. High-potential family members need to be identified as early as possible, and groomed as long as necessary for the CEO role. The problem is, such members may not always be available, and the conflicting expectations and interests of family members have to be balanced.

Type B: CEO cannot be a family member. In this type of company, the board thinks it prudent to separate management from ownership as it is aware of the level of scrutiny it will face if a family member CEO fails. The next CEO can be hired internally or externally. Some companies even exclude family members — and consequently the exposure to family discord — from the senior management, with the aim of drawing the best candidates.

Type C: CEO must be selected internally, no matter whether he/she is a family member. Most organizations fall into this type. They think first about continuity, stability and the CEO’s understanding of the company, its culture and history. They believe that the board has a large enough talent pool from which to choose the next CEO. They can identify and train successors at an earlier time than Type A companies.

Type D: CEO may be hired internally or externally, no matter whether he/she is a family member. The board of this type of company thinks the top priority is to ensure a candidate is capable, ready and fit to lead. Therefore, there will be no specific limitation on the candidate pool and selection process. The board might need an appropriate approach to benchmark family members and internal talent against external prospects.

In each of these scenarios, the chairman normally plays a crucial role orchestrating the succession planning process. Some chairmen are more hands-on than others. One chair we spoke with has regular interactions with the CEO and HR director to ensure that the most talented people are kept motivated and challenged. “As the chairman, I make myself known in the businesses,” he said. “I visit international operations and speak regularly to managers of different levels in order to identify the pipeline of most talented and suited people. I spend time with key prospects, getting to know them personally and also their families when possible.”

The chairman cannot possibly manage CEO succession alone. Much of the heavy lifting will fall to the nomination committee (or its equivalent) to drive the process, albeit under the close watch of the chairman. There are many factors to consider, let alone the ever-changing market, so the board needs to think about what kind of CEO the business needs.

When planning CEO succession over the long term, it may not be possible to create a precise specification for the CEO role, given uncertainties over the future state of the market. What matters is that the nomination committee constantly re-evaluates the skills and attributes of the next CEO in terms of the changing business environment and the strategic direction that the organization needs to take in the next five to 10 years. This might mean looking for someone with deep knowledge of a related industry, for example, or someone familiar with new, unexplored fields.

Meanwhile, the HR function has an enabling role to play. As a partner of the board, the HR director is expected to manage the executive training program while keeping an eye on external talent who might one day prove their value to the company.

During our discussions, many chairmen expressed the hope of adopting a more optimized process of talent management and CEO succession planning. The HR director of a family business should, therefore, advise the chairman, CEO and nomination committee on how to make succession plans, identify qualified candidates, understand shareholders’ cultural values, manage shareholder expectations, organize board discussions on succession planning, evaluate the current CEO, and build capacity of current directors and next-generation successors.

The HR director should also team up with external consultants to compare talent outside the business and deliver metrics for fair evaluation. The board should be kept informed throughout the process.

The next question is how to foster outstanding management talent within the family.

When family members with the requisite talent and potential are identified, they should be given roles in core departments and even at board level if they are ready. “The ideal way to prepare them for the CEO role is to slowly let them grow and mature in management roles and with increased responsibility,” said one chairman.

A number of companies put their high potentials through executive education programs offered by business schools. Some insist that younger family members aspiring to senior executive positions gain experience and perspective outside the organization, preferably in a global MNC and not necessarily in a family business.

Some companies have strict criteria for family members being considered for senior management positions. They go to considerable lengths to ensure that they have to jump through all the same hoops that would be expected of a non-family member. “In the family charter, it was decided that family members must have a university degree and have gained relevant experience outside the family business for at least 10 years. In terms of salary, they can only earn the market rate and no more than a non-family member would be paid in the same role.”

Whether the family branches are capable of providing the company with its next CEO or chairman, it is extremely important to secure the next generation’s interest and attachment to the business. As the family branches expand and spread across different geographies, it is increasingly challenging for the family members to stay connected, to know each other and to share a common value, purpose and business interest. Thus, current family leaders, and the chairman more than anyone else, should make it a priority to promote opportunities to get together. Family events, family clubs and celebrations are used by our interviewees to create, develop and syndicate the family’s values.

Almost all the chairmen that we surveyed believe that the CEO should be an active member of the board (with the exception of those countries in which the prevailing corporate governance model does not allow it). Not only is a seat on the board a key incentive for aspiring CEOs, but a clear demonstration to the CEO that he or she belongs and is expected to participate fully in decision-making at the highest level. It also ensures transparency and a unity between governance and operational execution.

As a board member, the CEO has direct and regular contact with other directors, and thus becomes more engaged, aligned and accountable. One chairman was adamant that the CEO must be on the board because he or she will have “a much better sense of what is strategically important, what is sensitive, what is top of mind for the other directors. The head of the family council is also a board member so the CEO can hear firsthand what keeps the family shareholders awake at night.”

Family businesses are in the unique position to build a well-balanced and highly competent board, with an optimal mix of long-term committed shareholders’ representatives (the family), a representative of the management team (the CEO and, more rarely, the CFO or another senior executive) and top-class independent directors who bring complementary capabilities.

Interaction between the family and management

Most businesses we surveyed, and all of the larger, more established ones, maintain an arms-length relationship between the CEO and the family. “This needs to be organized in a strict and controlled way,” said one chairman. Shareholders cannot interfere directly in the operational aspects of the business or in the CEO succession planning process.

Some companies specify that the CEO should never be a member of the family council. Others put formal restrictions on individual family members contacting the CEO and vice versa. Instead, any contact between the board and the family is channeled primarily through the chairman.

There are typically two occasions a year when management and the family meet. One of these is always the equivalent of an annual general meeting at which the results are disclosed. The CEO, often accompanied by the senior management team, provides family members with a detailed update on the state of the business, setting out the key strategic, financial and operational issues.

In addition to these biannual meetings designed to keep family members informed about the business, some companies have formed “clubs” for the younger generation so that they can gain a sense of belonging to the broader family and its enterprise. This has two particular benefits: first, to inculcate the vision and philosophy of the business in all family members (regardless of whether they will participate in the running of the business); and second, to provide inspiration for young people with an affinity for the business and give them opportunities to show their potential.

Rarely is there anything more critical to a family enterprise than securing its leadership succession. Yet many family businesses are giving the matter far too little attention and do not have a coherent plan. The chairman plays a pivotal role in making sure that the optimal process is followed, obtaining consensus among family members along the way and ensuring that progress is communicated in a timely manner, usually through family council channels.

The board must be prepared to make the necessary commitment to secure the best possible outcome. This often means ensuring the right governance model is in place and enshrining a more formal approach to CEO succession in the family charter. Aligning the family shareholders with the board is a golden rule for successful CEO succession.

CEO succession is far too important and complex to be left to guesswork. Conducting a successful CEO succession program takes time and includes a complex list of activities. Even if all these things are in place, there is still no guarantee of success in appointing the right person. However, much of the risk can be mitigated by approaching the CEO succession holistically and by employing the most precise assessment tools.

Such tools provide a thorough analysis of the functioning of the board, helping define the company’s culture and the shareholders’ values, while indicating how the capabilities of board members might be developed (especially the less experienced next generation family representatives). At the same time, they identify CEO succession candidates’ strengths and weaknesses, as well as their potential to grow and competence in the job.

It is noteworthy that effective succession planning typically starts years before a CEO retires or leaves. The earlier the plan kicks off, the more options that will be available. Planners may take a page from the company’s strategic playbook.

At a time when market segmentation goes hand in hand with industrial integration, some family businesses find themselves on the horns of a strategic dilemma: to put all their eggs in one basket, or to expand or completely transform the business.

Compared with those who wait until the last minute to hunt for a successor, a successful board tends to view succession planning as an ongoing process. As one chairman put it, “We talk about CEO succession from time to time. Instead of rushing out any plans, we want to keep the entire process under control.”