Emotion & Corporate Succession
About 90 percent of conflict in corporate succession is psychological, not strategic, and yet they receive little consideration in most cases. The emotional component is the most underrated reason for a failed succession.
In addition to economic and financial fears, the seller or “old management” may fear losing influence and recognition. Without clear ideas for life “after the business,” the motivation to hand over your life’s work into someone else’s care is understandably low.
People express and cope with emotions differently. Some entrepreneurs respond by suppressing the question of succession, which prevents the process from getting started. In many companies, the founder is still involved in business operations well into old age, which impedes the transfer of the business and delays the initiation of the handover process. As a result, new management has little opportunity to run the company in their favor. The identification with one’s own life’s work is sometimes so strong that one can’t see alternatives in terms of the company’s future.
Questions facing the founder include: How can I use my experience to secure the succession of my company in the future? What would a suitable corporate succession look like, and how will my role change? How is my influence changing? What are my motives, and how will my family and myself live with the change?
Seven Phases of Change
In many companies, the rule “emotions shouldn’t play a role here” still applies. In the end, it all depends on the situation. However, this rule is not expedient and can hinder essential business decisions, such as when the company is transferred to new management, which affects everyone involved.
Experience shows that the change process goes through several phases, outlined below, until the people involved adopt changes in their behavior or attitude:
- Shock: people feel a discrepancy between expectations and reality.
- Rejection: people see no valid reason for the difference.
- Insight: people understand the need to change.
- Acceptance: people realize the change is permanent.
- Trying out: people try out new behaviors to cope with the change.
- Recognition: people recognize and reflect upon the reasons for the failure or success of the change.
- Integration: people adopt successful and beneficial behaviors into their behavior repertoire.
How Emotions Can Hamper Negotiations
Selling a business is not just about facts and figures; intangible factors also play an essential role. Findings from business psychology show what influence emotions have.
In the life of a typical, medium-sized company, transferring ownership is an inevitable decision–and a highly emotional one, too. After all, one has invested sweat, blood, and soul into the company’s success, often for decades. Giving up all of that is difficult. However, there comes the point at which an entrepreneur has to ask himself how to arrange his succession. Should he consider “mergers and acquisitions?”
There are a few things to consider here because M & M&A is not part of the day-to-day business for most of the actors involved, apart from M&A advisors and professional investors and investment companies.
For sales to not fail at the very end of the process, everyone involved should be aware of the psychological factors of an M&A transaction from the start. Behavioral economics studies show that it takes up to five years for the company founder and owner to reach mental readiness to part with his company, and at the same time to be prepared to accept a fair price.
When owners of medium-sized companies want to sell their businesses–for example, to private equity investors–they are breaking new ground. They are confronted with a wide variety of information and assessments which they find difficult to classify. Unlike their familiar everyday business, they cannot rely on their own experience, making the transfer of business an unknown and frightening territory.
It is worth taking a closer look at some psychological phenomena to develop an awareness of the effects during discussions and negotiations in M&A processes.
The endowment effect plays a role in everyday life, such as when selling a car. Despite a professional appraisal by an automotive expert and looking at the “Blue Book” value, many sellers believe their cars should be worth more. After years of care, the car shouldn’t be thrown away so easily!
The longer you call something your own and value it, the greater the emotional bond and the pain of separation. This is especially true when it comes to your own life’s work. Emotional attachment makes a considerable difference in the value of a company, resulting in many entrepreneurs demanding a high purchase price as a form of “compensation for pain and suffering.”
The endowment effect is based on a hypothesis by Richard Thaler, a US economist, and Nobel laureate. According to Thaler, people tend to assign an intangible premium to the value of their goods, which is determined by the emotions associated with them. Due to the endowment effect, the willingness to pay a specific purchase price and the desire to sell a particular, emotionally charged good are not congruent. Empirical observation of this phenomenon in action contradicts the assumption that people are primarily rational beings who set their preferences and make decisions based on purely logical aspects.
Information and knowledge asymmetry
Most M & M&A processes begin with a knowing seller and an ignorant buyer who is most knowledgeable of the industry and fundamentally interested in the company for sale. At this point, there is an information and knowledge asymmetry. After agreement on confidentiality or non-disclosure, initial information is exchanged in brief profiles and memoranda.
On this basis, potential buyers will consider whether the offer interests them, whether they will pursue it, or whether they will withdraw from negotiation. Information density increases if discussions continue. As part of due diligence, the potential buyer gains deep insights into the business model: commercial or market due diligence (i.e., the analysis of the business model, including a market analysis), financial due diligence (i.e., the examination of the economic situation of the company for sale), legal, due diligence (i.e., the review of all corporate law aspects), and tax due diligence (i.e., the review of tax obligations).
A carefully executed company analysis offers the potential buyer the chance to know the company better–sometimes better than the seller. However, even extreme thoroughness and accuracy of due diligence do not protect against a misjudgment of the actual conditions in and around the company, which is why sellers and buyers commonly agree on withholdings in connection with guarantees.
“Every number that is presented to you as a possible solution to an estimation problem creates an anchor effect,” writes Nobel laureate Daniel Kahnemann. He adds: “The list of anchor effects is endless.” In other words, whoever wins first prize in an M&A transaction call has already succeeded in a way because he has set a relevant framework for all other parties involved in further negotiations.
Therefore, in an M&A process, the seller’s tax advisor has a mainly responsible role. He is the company’s confidante. Most of the time, he is the first to know about the sales request and likely to be the first to be asked to determine a possible sales price. The result of his calculations sets the anchor. It is possible (and even probable) that the tax advisor sets too high a price to secure the goodwill of his client. Also, suppose the purchase price is at the absolute upper limit of what is justifiable, and there is no sale. In that case, the consulting mandate remains with him, which is otherwise usually lost.
The initial mind-setting in the salesperson and tax advisor dialogue should not be underestimated, especially concerning overly ambitious goals. Kahneman writes, “We know that people can be fulfilled by an unshakable belief in a conviction, no matter how absurd, if they are encouraged by a group of like-minded people.”
Communication Is Key
A corporate transfer may also engender resistance from the successor who is to take over the new management. Confronted with many expectations and requirements, the successor may feel overburdened or that his expectations are being neglected. Often the willingness to take on complete responsibility is not fully developed.
Open, transparent, and constructive communication about goals and the company handover process to secure the company’s future acknowledges the accompanying emotions. Selling a company represents a profound change that spans all levels of the organization. Most people feel uncomfortable and insecure about change. Leaving your comfort zone and giving up well-known, safe routines go hand-in-hand with various feelings of insecurity to fear.
The management of companies, especially family businesses, is not only based on rationality; emotions and intuition play a role in every decision, too, consciously or unconsciously. It is, therefore, essential to bring emotion and rational thinking into harmony, not to see them as opposing forces.
Leading through a change process is also shown through emotions. It behooves the business owner to be aware of these emotions in himself and the other people involved–employees, customers, suppliers, etc.–and deal with them accordingly.