Family businesses can take a lifetime of hard work to build. So it would be prudent to have a comprehensive succession plan in place to ensure the enterprise is passed down smoothly to the next generation. But a 2008 PwC survey found that 49 per cent of companies have no such plan.

Family businesses can take a lifetime of hard work to build. So it would be prudent to have a comprehensive succession plan in place to ensure the enterprise is passed down smoothly to the next generation. But a 2008 PwC survey found that 49 per cent of companies have no such plan.

Three out of four businesses in Britain are family-owned, employing nearly half of the UK work force.

Moreover, family firms are the most productive: on average they make £29,000 ($45,658) turnover per full time member of staff as against £21,000 in non-family businesses.  So there is a real economic case for encouraging business succession.  At present only 24 per cent of family businesses survive to the second generation and 14 per cent to the third.

Yet for such a big problem, it is one that seems to be ignored. There are a number of reasons which, although not prudent are perfectly understandable, as to why businesses do not properly plan for succession.

Yet, a failure to plan generational change may leave a business with heirs who are unprepared or uninterested in continuing the commercial legacy. The result is often business failure. 

Passing the family business on to the next generation is difficult. It will usually take between three and five years to build a suitable new holding structure. The uncertainty that arises during this period can have a detrimental affect on a company.

In the UK, 49 per cent of business owners had a succession plan in place, but of those, only 30 per cent had chosen a successor.

The challenge

The essential challenge for advisors is to structure ownership and control to ensure the business continues to be properly run while at the same time ensuring the family can enjoy the fruits of that business and can pass it on to future generations.

The business needs to consider for whom it needs to provide for and how. The issues are likely to be financial: does the succession need to provide an income stream or capital, and for those working in the company or the extended family? Sometimes, especially with the larger concerns, it is strategic control that needs to be addressed. 

There may also be external threats to the business, which also need careful consideration so the appropriate action can take place: mental instability or emotional susceptibility of family members; taxation; insolvency; divorce; and Inheritance Act claims can all be relevant.

The family charter

Often, it is difficult to separate business issues from family issues. Sometimes therefore, the first step is for all family members to agree the terms of a "family charter", which identifies the assets that are "family assets" and sets out in principle how they are to be managed and who is to benefit from them. Even if a formal document is not drawn up, it is essential that the key family members are in agreement with the succession plan and understand what is expected of them.

Protective shields

Part of the succession plan will involve a consideration of how external threats to the business can be addressed. 

On an individual level, pre-nuptial agreements have a role in protecting business assets on divorce, and lasting powers of attorney can provide for assets to be managed if a person loses capacity, 

At a business level, decisions need to be taken about operational control and the composition of the board, and these decisions need to be kept under review. 

In terms of business structure, it should be remembered that particular aspects of the business may be better carried out by a subsidiary entity, be that a company or a limited liability partnership. If the business is structured in the most appropriate way, succession planning can be made easier.

Options for collective ownership

One of the main problems faced by a business owner with several children is that he or she wants to treat his children equally but he does not want to fragment ownership of the business.           

If the business is run as a company then one possible option is to split the share capital into different classes:

•           Non-voting preference shares

•           Non-voting ordinary shares

•           Voting ordinary shares

In this way economic ownership of the company can be divided while at the same time shareholder control can be concentrated in the hands of just one chosen family successor.

At the same time it might be appropriate to amend the Articles of Association to:

•           Prohibit the transfer of shares outside the lineal family

•           Include pre-emption rights for shareholders and

•           Confer absolute discretion on the directors to decline to register a transfer of shares

Setting up a family trust should also be considered as part of the succession plan as it can:

•           Separate control from economic value

•           Enable centralised decision-making

•           Confer discretion over future benefits

•           Offer significant long-term asset protection

A trust will be particularly appropriate if the plan is for management of the business to be carried on by a professional team but for ownership to stay with family members. If you go down the trust route you will have many complex decisions to make although it is a powerful and effective option: a trust can be established during the individual’s lifetime or in their will.

When setting up a trust, the most important consideration is the identity of the trustees. Often, rather than appointing family members to act in this role, it is better to appoint professional trustees who are able to act impartially.  There will be other issues to address:

•           Who has power to appoint replacement trustees?

•           Should there be more than one individual trust?

•           Who should be included as beneficiaries?

It is also very important to consider the tax implications of setting up a trust. Unfortunately these are too lengthy to explain in this article. Trusts can appear complex – there are many decisions to be made - so good legal representation is essential, but with proper advice they can prove very beneficial.

Whatever is decided, the business owner should be looking to make arrangements that can potentially continue for the benefit of the second and possibly the third generation. The arrangement should be sufficiently flexible to cope with changing future circumstances - whether that be family circumstances or legislative changes.

Conclusion

The issues of succession can be complex and might take time to resolve satisfactorily.  However, ignoring the subject can significantly reduce the chance of a family business surviving a succession without significant damage being done.

Not all the suggestions discussed above will seem attractive. Every case is different and the ideas are intended merely to illustrate the approaches that can be taken. They also illustrate the complex decisions that may need to be taken and hence the reason why forward planning is essential. If the end result is a successful transition of the business then the effort will have been worth it.