How to Reduce Family Business Generational Transition Failure

There are four key items independent directors should prioritize to support durable, multigenerational family enterprises.

Generational transitions in family businesses are critical junctures that can shape the future of the enterprise, often unfolding over 10 to 15 years and now occurring alongside significant market shifts driven by macroeconomic forces and the convergence of exponential technologies.

Strong performance today does not guarantee success in the future, as many family businesses face vulnerabilities tied to what EY believes are the six principal causes of generational transition failure.

With few large family firms surviving beyond five generations, independent directors play a vital role navigating these complexities. “For independent directors on the boards of these larger family businesses, the stakes are high. Their role is not merely advisory; it is essential in steering family enterprises through the complexities of generational change," said Brock Griffiths, EY Americas Family Enterprise leader.   

The Six Principal Causes of Generational Transition Failure

Larger family businesses often find themselves at a crossroads during generational transitions, facing a range of challenges that can affect their long-term trajectory. The six principal causes of failure serve as a framework for understanding common pitfalls, providing insight into the dynamics that can derail even well-established enterprises. 

Below is a closer examination of these factors:

1. Inactive owners and beneficiaries. As family trees expand, the percentage of active owners compared to inactive owners typically declines. This shift can lead to a disconnect, as some inactive owners may view risk differently or prioritize immediate liquidity over long-term reinvestment. This tension can create friction with active owners who are focused on growth and sustainability, complicating decision-making and strategic alignment.
2. Uncoordinated financial demands on business profits. Balancing the capital needs of the business with the liquidity demands of family members is a delicate process. When financial expectations are misaligned, it can limit capital expenditures and growth initiatives, leaving the business ill-prepared for future needs. Conversely, this misalignment can frustrate family members seeking more immediate returns, leading to dissatisfaction and conflict.
3. Unclear boundaries between the family and the board. The traditional three-circle model of the family business system, which was created by Renato Tagiuri and John Davis in 1978 and categorizes roles among family, ownership, and management, is less effective as ownership and governance structures grow more complex because of the increased use of generation skipping and dynasty trusts. As structures become more intricate, roles and responsibilities can blur, leading to confusion and conflict. Without clear boundaries, decision-making can become inconsistent, undermining governance effectiveness
4. Lack of nonfinancial capital development. Successful generational transitions rely on a comprehensive understanding of capital that extends beyond financial assets. Human, intellectual, and social capital—collectively referred to as nonfinancial capital—are critical components of long-term success. Neglecting these dimensions can weaken the family’s stewardship capabilities and diminish the business's resilience.
5. Inadequate business governance and oversight. Weak governance structures can erode business performance and diminish equity value, particularly during transitions. Those persons responsible for appointing board members, such as trustees and voting shareholders, should understand the future vision for the business and the skill sets and experience needed to provide effective oversight.  
6. “Elephant in the room” issues. Often, the most significant risks are the hardest to address. Whether they stem from owner-level disputes, business-level challenges, or broader industry and macroeconomic factors, failing to address these issues can create a toxic operational environment.

The Role of Independent Directors

As family businesses navigate generational transitions, those responsible for governance and oversight need to remember the six principal causes of failure to reduce generational transition risk. Therefore, the role of independent directors becomes increasingly critical. 

While challenges, such as inactive owners, financial misalignment, and unclear boundaries, may not fall directly under the board’s purview, they can significantly impact the overall health of the enterprise. So, what can independent directors do to effectively support family businesses during these pivotal moments?

Below are four actions independent directors can take to materially influence transition success:

1. Encourage the establishment of distinct governance structures. Independent directors should advocate separate governance structures for the family and the business. Such a framework supports clear communication and direction between the two governance systems. Family governance often focuses on developing a capable and cohesive shareholder base, while business governance oversees strategy, growth, capital allocation, and the operational performance of the business. By delineating these roles, independent directors can help align family and business interests and support a more collaborative environment. 
2. Support the development of capable next generation shareholders. Effective family governance is essential for preparing the next generation for stewardship, regardless of whether they work in the business. It clarifies roles and responsibilities by helping family members understand their contributions to the enterprise. The goal of a strong family governance system is to cultivate “patient capital,” or a shared belief among family members in the value of participating in a long-term, multigenerational business.
3. Ensure competent business governance. While family governance lays the groundwork for a cohesive ownership structure, independent directors must ensure that business governance systems operate effectively. This includes establishing procedures to facilitate qualified individuals can lead the company and steer it toward growth and long-term value creation. Transparency in reporting and the use of data analytics are essential to understanding growth opportunities and risks.
4. Create operational confidence. A well-functioning business governance system instills operational confidence, giving family members assurance that the company is being managed effectively. This confidence, combined with patient capital, creates a strong foundation that positions larger, multigenerational companies for long-term success.

Independent directors play a critical role in guiding family businesses through generational transitions. By fostering open communication, establishing clear governance structures, and addressing underlying issues, independent directors can support larger family businesses to not only navigate generational transitions but also to strengthen their long-term resilience.

Understanding and addressing the six principal causes of failure is not only a boardroom responsibility but also a critical component of facilitating the longevity and success of family enterprises for future generations.

The complexity of generational transitions tends to compound over time. It is never too early to start with advanced preparation.

The views expressed in this article are the authors’ own and do not represent the perspective of NACD.

The views reflected in this article are the views of the author and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.

Ernst & Young LLP is a NACD sponsor, providing directors with critical and timely information, and perspectives. Ernst & Young LLP is a financial supporter of the NACD.