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The rules and process of succession in family businesses is one of several topics related to family businesses, which are currently coming to the fore once again. Our law firm, Hronček & Partners, s. r. o., has been actively involved in this topic and the legal regulation of family businesses in the past, not only through several articles which focused on the basic aspects of family business, the action plan for the development of family businesses, and the amendment to Act No. 112/2018 Coll. on the social economy and social enterprises and on amendments to certain acts.

In order to provide a closer look at the topic of family businesses, including the process of generational change (succession) in this period, we are also preparing a webinar, which will be attended by several experts from various fields dedicated to the successful management of generational change.

One of the reasons for the "revival" of the topic of family businesses is the continuing support for family entrepreneurship through support instruments. One of these is the allocation of funds from the state budget by the Ministry of Economy of the Slovak Republic to address generational change in family businesses, which means that sooner or later it should be possible to apply for funds for the purpose of obtaining expert advice on succession and generational change. Whether intentionally or not, this timing coincides with a period when many Slovak entrepreneurs of the "first generation," who de facto emerged with the transition to a market economy, are considering retirement.

According to studies, family businesses account for 60 to 80% of all small and medium-sized enterprises in Slovakia, with up to 70% of them facing failure in transferring management and assets to the next generation.

Selecting new management is one of the most important decisions in the life of any company. While in international corporations, directors often change every 4-6 years, in family businesses, the owner may remain in management for 20-25 years.1 Generational change is therefore a long-term and complex process that requires thorough planning, discipline, and patience. It is not enough to take a course or study—training a suitable manager requires long-term effort. Failure to hand over a company often stems from underestimating the time and complexity of this process.

The succession process itself involves two main areas – the transfer of management and the transfer of assets, which do not have to take place at the same time but can be divided into several phases. It often takes several years for the successor to gradually acquire the necessary skills and responsibilities, along with an increasing share in the company. Successful generational change therefore requires planning to begin well in advance.

Because this is a complex process, we have prepared a list of basic rules that can help your family business successfully manage generational change and ensure that the next generation continues the business you have invested years of effort and work into.

Successful transfer of a family business requires thorough planning from the very beginning

Founders of family businesses often prioritize keeping the company in family ownership and management, with selling the business to an outsider being a last resort. When planning succession, it is important to consider the current situation of the company, whether it is in a growth or dynamic development phase, or whether it is facing market fluctuations, losses, or needs remedial measures.

The first key step in the generational change process is to determine who will be the new leader of the company. Various options need to be considered here:

a) Train a successor directly within the family,

b) Prepare one of the current managers or employees for this role,

c) Recruit a suitable manager from outside the company.

In addition to the company's interests, personal factors must also be taken into account, such as the founder's health, their desire to spend more time with their family, or their thoughts on when they want to retire.

Another essential step is a detailed review of the company's strategy. The founder should thoroughly analyze how the company is doing in a changing market, what the competition is like, what it plans to produce or sell in the future, and to what extent it depends on his or her personal leadership. It is important that the company's strategy is clear before a successor is selected, rather than adapting it to the person who will run the company.

At the same time, it is necessary to choose the right succession plan. This choice depends on several factors, such as the founder's health, their personal plans, and the current situation of the company.

Use of professional assistance from external sources

Generational change is one of the biggest challenges that no family business can avoid. Many founders do not realize how demanding it is, both in terms of processes and emotions, to transfer a company to the next generation. This process is complex and can take a long time. In addition, generational change often involves changes in ownership and organizational structure, as well as adjustments to the business strategy.

Working with independent and experienced advisors or mentors can be beneficial during this period. Experts bring structure, objectivity, and independent perspectives to the succession process, taking into account the education, work experience, motivation, and potential of family members compared to other talents within and outside the company.

Mutual trust and communication between generations within the company

Working relationships play a key role in family businesses. It is therefore essential to maintain open communication, prevent conflicts, and clearly define roles and responsibilities. It is important to have transparent decision-making rules in place and to adhere to them consistently. Studies show that communication failures and a lack of trust between family members are common causes of failure in generational change. Focusing on communication and trust-building significantly increases the chances of success. It is also necessary to eliminate generational prejudices and understand the differences between generations that have grown up in different conditions and have different experiences, especially in the area of digital skills, which are considered an important competence for the future.

The negative side of generational change is also represented by family conflicts, which often accompany generational change, but can be prevented in two ways:

a) By clearly defining the roles, competencies, and responsibilities of family members and non-family members, with regular evaluation and adjustment in line with the current corporate strategy.

b) By promoting open communication and providing feedback within the family and among employees. Senior managers should actively seek feedback and set an example for other family members.

Selecting a new leader and organizing the management of a family business

Just as every business has its own rules, selecting people for a family business requires careful consideration. The first and most important step is to identify the areas that the company needs to strengthen in the future and determine what knowledge, experience, and character traits family members and employees already have so that there is no unnecessary duplication. It is important to spend enough time defining the position to be filled. In many cases, the founder is assisted in selecting a new leader by an external consulting firm that is familiar with current labor market trends. Furthermore, defining roles and job descriptions should not be solely in the hands of the founder or owner, but should be the result of collaboration with the company's management. Ideally, a common vision should be achieved and a clear determination made as to what type of person the family business needs at its helm.

When setting up the right management model, it is important to realize that the new generation is coming into the company with an established history, well-established ways of working, and certain corporate cultures. The company often has long-term employees, including managers, who are used to the founder's management style. Customers, suppliers, and business partners are also often attached to the founder's personality and approach. Therefore, choosing the right management model is crucial. Every family business is unique and there is no universal solution, but there are different models that can be adapted to the specific needs of the company. Setting up the right management structure is challenging and requires a comprehensive approach and expert advice.

Adhering to the family business succession process

A successful generational change requires strict adherence to a management succession plan that includes not only the steps involved in the succession itself, but also the gradual transfer of managerial responsibilities and competencies, as well as the development and training of the new leader as they take over the management of the family business. An important part of this plan is also setting a time frame and specific deadlines for individual areas that are important for the company in the generational change process.

The succession plan consists of several main steps, including:

Preparation and training of the future leader,

Preparing the founder to step down as director,

Preparing the company for the arrival of new management,

Preparing employees for the change in management,

Transferring managerial competencies and further training of the successor.

For each of these steps, it is important not only to set specific deadlines, but also to estimate the time needed for their completion. Some steps can be implemented simultaneously, which increases the efficiency of the entire process.

Accurate valuation and determination of the value of a family business

Determining the value of a family business is crucial because generational change essentially represents the sale of the business, albeit within the family, and has a long-term impact on family relationships. The company is valued by an independent licensed appraiser using various valuation methods depending on whether it is a going concern or an asset-based business.

An expert valuation is required by law in cases where generational change involves the transformation of a family business and the transfer of the company (whether by way of a contribution or sale) from the founder's assets to a family holding company. The expert bases their valuation on various documents that form the basis for their opinion.

Company valuation is also important from a tax perspective, as it provides the founder with information about the value of the individual components of the company, including intangible assets such as trademarks, patents or know-how, which may not be included in the accounts.

Setting up a fair remuneration system in a family business

A family business can be a long-term source of income for the family, but also a potential source of conflict. It is important to clearly define who will own the assets, who will have the right to make decisions about them, and who will benefit from them. An incorrectly set dividend policy can disrupt the stability of the business and reduce the commitment of family members.

Transparency in remuneration is essential, as the family often expects the business to be a stable source of dividends and other benefits. The family should clearly define the rules regarding access to assets and the employment of family members in the future.

Establishment of a family council and family constitution

A family council is a regular meeting of family members that serves as a forum for discussing important issues related to the family, the business, and ownership, similar to a board of directors in a company. This body enables decisions on succession to be made based on agreed rules and provides a space for developing a shared mission, vision, and strategy for the family business. The family council is often convened when the founder announces that a family member may join the family business. These meetings promote the building of a strong family, a strong company, and the resolution of future ownership issues. They also help resolve conflicts and ensure the effective management of the company.

For a family council to function properly, it is important to have a family constitution – a formal document created through the joint efforts of the family. This document expresses family values, goals, and principles, and links family relationships to the business. A family constitution is not legally binding, but rather serves as a moral foundation, similar to a handbook written by the founders, which provides future generations with information about the goals and principles of managing the company. It can also serve as a basis for a shareholder or partnership agreement.

Proper tax planning and strategies

Generational change is often accompanied by business reorganization. In addition to lawyers and accountants, a tax advisor should also be involved in this process, as proper tax planning can significantly affect the amount of financial resources that remain to the founder after leaving the business.

There are several tools for effectively managing a family business from a tax perspective. The choice of the appropriate strategy depends on the specific circumstances of the company, and it is therefore essential to consult a tax law expert on these issues. The Slovak legal system does not specifically regulate family businesses, so the general rules apply to the process of inheritance, donation or sale of shares. However, in order to maintain business continuity, it is necessary to plan in advance tax strategies that may affect the transfer of the business between generations.

Merging assets into a family holding company and choosing the appropriate legal form

Effective management of family assets requires an overview of financial income, the status and structure of assets (both corporate and private). For this reason, it is often necessary to gradually consolidate family assets into a single entity, while ensuring tax optimization.

Consolidation is essential when transforming a family business, which involves not only a change in ownership but also the reorganization and restructuring of the company. There are two main tools for this purpose: family holding and trust management.

A family holding company acts as a central holding company that owns and manages subsidiaries, thereby ensuring the protection of assets and risks. If problems affect one or two subsidiaries, the remaining parts of the holding company remain unaffected. The holding company allows for the redistribution of profits generated by subsidiaries within the holding company and subsequent reinvestment under favorable tax conditions.

The choice of legal form for a family holding company depends on the needs of the family, costs, and future plans. The most commonly used forms are joint-stock companies, limited liability companies, or European companies. Another important step is to establish relationships between the owners and resolve potential disputes, for example through a shareholders' agreement or a partnership agreement.

Conclusion

Like company management, generational change is not a homogeneous process for which clear and precise rules can be established regardless of the individual facts and circumstances of each case. However, in this article, we outline a range of issues and topics that you will generally encounter when considering generational change or other changes within a family business. Cooperation with experts in the fields of law, taxation, financial management, and communication can be an important prerequisite for a smooth and successful transition of company management and assets to the next generation.

As mentioned in the introduction, we will continue to focus on the topic of family businesses, including the publication and preparation of a webinar, about which we will inform you in due course.