One of the unexpected findings that emerged from the research on succession in Russian business was an almost complete absence of CEO replacement by the second generation - sons or daughters of the owners. Below you will find reasons and possible explanations for this phenomenon.
Our research on succession in leading Russian companies revealed, among other things, a not insignificant finding: the nearly complete absence of cases when company owners passed their business down to the second generation (sons or daughters of company founders). We documented only four such cases over the last 10 years: the new CEOs were Sergey Mikhailov (Cherkizovo), Andrey Guriev (PhosAgro), Evegeniy Zubitsky (Koks), and Aleksandr Manchenko (Metallservis).
It’s possible that this is related to the relative youth of the first generation of Russian businessmen, who started their work in the 1990s. Most of them are now 55-60 years old, and the question of succession will be relevant to them in a few years. But will their successors be the younger members of the family, as is the case in most private companies world-wide? We have strong reason to believe that in this case, Russia will go its own way.
According to research conducted by PwC (PwC: Private Business in Russia, 2012), only 10% of polled business owners wanted to pass their business on to their heirs (in the rest of the world, this figure is about 41%), and another 14% planned to pass it along, but with the recruitment of appointed senior management (worldwide – 25%). In other words, more than 70%(!) of Russian business proprietors do not want to keep their business in the family after they retire.
In other words, more than 70% (!) of Russian business proprietors do not want to keep their business in the family after they retire.
What is the reason behind such a radical position from the majority of successful Russian businessmen, and what does this mean for the future of their companies, and of the entire Russian economy? Is it possible that they are all like Vladimir Potanin, who became a supporter of the ideas purported by Warren Buffet and Bill Gates regarding the necessity of limiting heirs to a “minimum living wage,” and giving the rest to charitable foundations? And how do you practically do that when, unlike Gates and Buffet, Russian businessmen manage companies that are non-public and not very transparent, the cost of which is rather substantial, especially in the owner’s absence?
It seems to us, that the reasons should looked attogether, as the repercussions of a mass exodus from the market of the first generation of business owners could be quite disastrous for the Russian economy. Disastrous enough to consider two questions: “What will happen to the value of Russian companies when an entire generation of owners begins to actively sell their assets so that they can retire?” and “Who will become the new owners of these businesses?” in order to understand what potential economic risks are inherent in the reluctance of most Russian proprietors to passon their businesses through inheritance. Of course, being rational investors, they would hardly sell their businesses for next to nothing to today’s only real buyer – the Russian government – and still give assets to the next generation; but how many heirs are going to be ready to manage them? And is the low estimation of their children’s management skills at the bottom of the current owners’ reluctance to make the business a family affair?
From our perspective, there are several reasons. The first is associated with the nature of political and economic development in Russia, which is characterized by a high level of volatility and uncertainty on the one hand, and a constantly increasing role of government on the other. Perhaps this isn't the worst environment for business, but it is now here near ideal for sustainable development of a mature company. Many parents wouldn't wish running a business in that environment on their child.
The second reason is related to the weak apparatusesto protect proprietary rights in Russia, whereby it is possible to lose your business at the drop of a hat, especially when it has a new chief operator – members of the second generation don't have the same high-powered contacts that the founder does. And now we've reached the main reason, in our opinion, why Russian businessmen are skeptical about the idea of passing on their business through inheritance. It's no secret (and our research yet again confirmed this) that a businessman's informal contacts and social capital play a key role in Russian business. Your children can inherit a plant or a factory, but how do you leave them your relationship with the governor, or with the representatives of a large client? And if it's not possible to pass down your social capital, then there's no point in passing down a business that won't survive without the connections of its founder.
Though we agree that it's impossible to fully pass down your social network through inheritance, we do think that heads of Russian companies have ample opportunity to prepare their children to be effective owners and to ensure a safe transfer of responsibilities. The experience of other countries allows us to see and realize these opportunities, though it is true, that it's necessary for Russian businessmen to look to external professional specialists who study and manage succession for help. Below we would like to point out a few of the most common situations.
Members of the first generation of owners, generally, don't differentiate between the concepts of ownership and management; even if an owner isn't the formal CEO, his level of involvement and operations management is extremely high. This is why they think about succession as preparing their children for ownership and management of a business at the same time: for the reproduction of the existing model. And they rightly believe that it's practically impossible. The experience of other countries suggests the need to designate between the functions of “effective ownership” and “effective management,” and to prepare the next generation to first fill the roles ofeffective owners.
Effective owners maintain and, in the long run, increase the value of their businesses not on account of their direct management, but on account of their creation of, support of, and effective personal participation in the system of business governance. This system provides a frame for the recruitment, retention, and effective actions of senior level managers – the CEO and his team. An effective owner knows his industry and his team quite well; however, he maintains distance from them. He is an active observer, involved only in moments when it's necessary to change the rules of the game or those who play under him, or when the business is in crisis. To effectively fill this role, children of businessmen need systems thinking, strategic vision, risk management and talent management skills, financial and investment literacy, and an understanding of corporate law as well as soft skills, such as the ability to listen and hear, to convince, and not command, and to effectively cooperate with mature professionals outside of the power structure.
Is it possible to teach this? It is difficult for businessmen of the first generation to pass their knowledge and skills on to their children, as their knowledge is a product of their experience, their own trial and error on the way – it is a part of them. Some radical parents try to push their descendents down their same path, dropping them into the hot waters of business. However, such approaches generally turn out to be ineffective for acquiring the necessary competencies for effective ownership, as well as for motivation to work in the family business.
The experience of successful family companies in the West and the Asian countries shows that it is far more effective to slowly introduce successors to the range of issues that their parents regularly address as business owners. Such inclusion provides for a certain level of overall development, the acquisition of technical and behavioral skills that can be gained in leading international universities, business schools, and through individual lessons with coaches and mentors. Many family companies organize special multi-year programs to prepare effective owners, which include formal education as well as specialized courses developed for their business. The experience of such families, like the Wallenbergs, shows that consistent work over a fifteen-year period makes it possible to stably prepare family members to be effective owners.
It's worth considering how to compensate for the loss of social capital that occurs when transferring a business to the second generation.
And what about the Russian idiosyncrasy, the paramount importance of the founder's social capital for the success of the business? You can’t expect that a father could completely pass on his social capital to his children, though a concerted effort in this arena is always somewhat beneficial. For that reason, it's worth considering how to compensate for the loss of social capital that occurs when transferring a business to the second generation. Corporate governance appears to display definite potential. A traditional approach is to elect people to the board of directors who could share their business connections. The second path for expanding social capital is by recruiting a shareholder who possesses the necessary contacts. In this case, it’s necessary to pay out a cut of the owner’s share and influence, in exchange for social capital and the business’s potential increase in value. The third method is the recruitment of managers with the necessary social network, or its elements. And, finally, we can't forget about marriage: the traditional method of increasing social capital.
The preparation of children for the role of effective owners doesn't mean that they can’t replace their fathers and become CEOs of their businesses. That scenario requires tremendous effort and talent, and is fraught with significant risks, but it is possible. This major succession program should be seen as the exception, not the rule. In order to successfully implement this scenario, it requires, first and foremost, the ambition of both parties, and a well thought-out, long-term program of preparation. In addition to the company founder's participation, it should include the participation of professionally trained assistants – managers, mentors, coaches, advisors. There are two classical models for breeding a future CEO: apprenticeship, and grooming.
The experience of other countries suggests the need to designate between the functions of “effective ownership” and “effective management,” and to prepare the next generation to fill the roles of effective owners.
Apprenticeship assumes that the successor works hand in hand with the founder of the company, taking over his experience, knowledge, and contacts. This model provides the successor an opportunity to become thoroughly acquainted with the business, but limits his development within a company, and rarely creates the opportunity for fully independent work – an experience that was essential for every CEO. Grooming eliminates this problem, as the successor, before taking responsibility for the family business, works in different companies or in their own business. The main goal is to expand his business horizons and for him to learn to work independently from his parents, which ultimately helps formulate the ability to independently make management decisions. As our research on Western practice shows, successors who have work experience in different companies deliver better results. In addition, investors and the markets respond positively to the appointment of a member of the next generation who has international education and work experience in different companies.
Process of Succession
Succession is one of the most complicated tasks that every business head faces. The cost of mistakes in this area is very high, and most businessmen have no experience in transitioning a business. Most business owners approach decisions about this problem the same way they approached all other problems related to business development – independently, through trial and error. Meanwhile, international experience testifies to the fact that external professional help is necessary for this process – help from board members who have been through cases of succession in different companies, from consultants who focus on succession planning, or simply from experienced, independent advisors.
Collaboration with professionals allows the owner to identify key issues of succession, see possible solutions for them, and develop a program of succession unique to his business. The basic issues, in our opinion, are the following. First, the next generation’s willingness and ability. Second (the answer for which is inaccessible without thorough discussion of the first) – what will be the target model of ownership and management of the company after responsibilities have been passed on, and what kind of role will each participating member of the next generation play in that model? Third – how will you prepare the successor for his future role? Fourth – what are the fundamental risks in transferring responsibility, and how do you manage them? And, finally, the fifth – what will happen to me?
The earlier an owner starts to think about these questions and find working answers, the higher his chances of successfully passing on ownership and responsibility. Succession is something to which the following rule is fully applicable: better late than never. Even a plan for transferring responsibilities, whipped up in two months, is more effective than a spontaneous move. This is a sitation where deep reflection leads to effective action.
This article was published a part of the seventh issue of Talent Equity Newsletter "Succession in Russian Business".
To read all other journal issues, please follow the link to TE Newsletters page.