It is estimated that for between 3,000 and 5,000 Hungarian family businesses – typically small and medium-sized enterprises – the issue of generational succession is either already a reality or will soon become so. Based on international experience, this process is successful in only 20–30 per cent of cases between the first and second generations. The success rate deteriorates further for subsequent generations.

This phenomenon affects not only the domestic SME sector but is also evident across Europe’s developed market economies. The literature refers to this directly as a ‘succession crisis’, which is particularly worrying in Germany, for example, where the medium-sized enterprise sector, the ‘Mittelstand’, forms the backbone of the country’s economy. According to a 2024 report by KfW (Kreditanstalt für Wiederaufbau), 30 per cent of German business owners are over 60, which amounts to more than 1 million people. Of these, roughly 125,000 owners begin looking for a business succession solution each year.

We outline the three main approaches to business succession and their typical challenges below.

Succession within the family

It is an understandable desire for a significant proportion of founders that their business – the embodiment of their life’s work – should be carried on by their child or children, who take their place. In this case, the fundamental question is whether there is a potential successor within the family who is both willing and capable of taking up the baton. Fortunately, there is often such a family member, which, whilst providing a good foundation for generational succession, by no means guarantees success.

One of the main tasks in planning and executing the handover is to clearly separate the roles of owner and company director, which have typically been intertwined up to that point, particularly if, alongside the chosen successor, there are family members who, whilst not taking an active role in the management of the company, will also succeed the founder as owners. That said, it is worth considering at this stage the structures and mechanisms through which the future owners can exercise oversight and control over the new managing director’s activities and performance – without this coming at the expense of family harmony and relationships.

The handover of the role of company director is in itself a complex challenge, which must take place between two different generations, two potentially different personalities, professional backgrounds and styles. It is important that the handover takes place within the framework of a pre-planned and controlled process, culminating in the transferor genuinely letting go and the successor genuinely taking the helm. It is often the case that this letting go does not materialise in day-to-day practice; the outgoing family member continues to visit the company and, taking advantage of their informal position, interferes in the company’s operational management by bypassing the new leader. It is easy to see that this parallel management model is detrimental both to the organisation’s functioning and to the family relationship between the transferor and the successor.
In parallel with the handover of the company management role, it is worth considering the manner and means of exercising the now-separate ownership role, as well as succession within this role.

Transferring the role of company director to someone outside the family

If there is no successor within the family to take over the management of the company, but the family wishes to retain its ownership stake in the company, it is possible to entrust its management to a person from outside the family, such as a professional manager. This solution is similar in many respects to a handover within the family, yet it has its own specific characteristics.

In this case, too, the process begins with the separation of ownership and management roles. The main difference compared to an intra-family handover is that the new company director will not, as a rule, be an owner, so the principal-agent problem becomes even more acute. It is therefore particularly important to ensure that the company director’s incentive structure is aligned with the owners’ interests. There are numerous techniques available for this, ranging from performance-related bonuses to the gradual transfer of ownership to the managing director. However, one must be prepared for the fact that professional external management will, on the face of it, cost more than what the founder-owner has so far paid to themselves in the form of managing director’s remuneration. This is only at first glance, however, because due to the overlapping roles, actual management remuneration has not been transparent to date; the ratio of salary, dividends and any personal expenses paid by the company has been determined by other considerations (e.g. tax optimisation).

Handing over the management of a business to an outsider differs greatly, both personally and emotionally, from a handover within the family. Trust is a key issue, and one that is generally taken for granted within a family. With an outsider, however, trust must be built up mutually, which does not happen overnight. It is worth bearing this in mind when planning the handover process and, in parallel with building trust, gradually transferring full operational control, whilst, of course, introducing ownership control mechanisms. At the same time, it is a relief that any conflicts arising between the owner and management do not place a strain on family relationships.

The sale of the business

In the absence of a motivated and suitable successor, the family often decides to sell the business and use the proceeds to secure the family’s financial future. In a significant number of cases, the founder is still the company’s chief executive at this stage. With rare exceptions, however, a business can be sold much more easily and at a higher price if it has a management team independent of the owner, rather than the buyer having to arrange this following the founder-owner’s departure.

It is therefore advisable to plan for management succession in good time, even in the event of a company sale, and to implement this prior to the transaction. Should this prove unsuccessful, there is a type of transaction specifically designed to address the succession issue. In a management buy-in (MBI), an external manager or management team acquires the company with the specific aim of taking over operational control and setting the company on a new growth trajectory.

These transactions are typically financed by the buyers using bank loans; therefore, they are only feasible in cases where the company’s debt levels allow for the raising of additional credit.
Even in the case of a business that is well prepared for sale, it is necessary to allow for a minimum of 9–12 months until the transaction is finalised, and a further one or two transitional years until the purchase price is paid in full. This is because, when selling domestic family-owned SMEs, it is common practice for the buyer to pay a portion of the purchase price (typically 20–25 per cent) one to two years after the transaction is completed, provided that the business meets certain pre-agreed performance targets (earn-out).

Tools and structures supporting generational succession

If the business remains in the family’s ownership even after the founder has stepped down, it is advisable to plan and formalise in some way when and how individual family members are to benefit from the ownership and/or the assets generated by the business. The status of family members may vary even at the outset, and the complexity increases further as time goes on.

There may be successors who are involved in the management of the company and those who are not, or heirs who were still minors at the time of the first handover, as well as individuals who join the family from outside, for example through marriage, at a later stage.
One tool supporting generational succession is the family constitution, which sets out the family business’s guiding principles, vision and operating rules across generations. The family constitution itself has no legal binding force, but it can be linked to contracts or structures that are legally enforceable.

Commonly used structures that support generational succession and are legally binding include the asset management foundation and trust-based asset management. An asset management foundation is an institution with its own legal personality, which itself becomes the owner of the assets, whilst trust management is a flexible contractual arrangement in which the trustee acts as the owner but manages the assets separately and for a specific purpose in the interests of the beneficiaries. The main function of these structures is to keep the family business intact across generations and to provide the heirs with an income from the profits generated in a pre-determined manner.

Whichever path a family business chooses, in order to be among the 20–30 per cent where generational succession is considered successful, careful planning, timely preparation and consistent implementation are required. The most important steps are the separation of ownership and management roles, the complete handover of company management from the founder-owner to a management team independent of the founder – whether from within or outside the family – and the establishment of structures and mechanisms that ensure current and future owners’ control over and share of the income generated by the company.

Disclaimer: this article is a translation of our original article written in Hungarian, which you can find here.