What are the Options for Family Business Succession Planning
It’s 100% guaranteed that a business owner will leave their business. One way or another. At some point in the future. The only thing for debate is how you chose to leave and how prepared you are when it happens. Most family businesses never have these planning conversations because it’s a hard discussion when it includes the eventual death of the business owner.
Succession planning makes sure that the business continues into the future with the ability to thrive under new ownership and control. With more than 50% of business owners leaving their businesses unexpectedly (death, disease, disability among the biggest reasons). The more prepared the business is to operate without them the better the chances of survival.
Within a family business there are often hereditary considerations to take into account. It’s important to understand the difference between Ownership and Control in a business. It is often not clearly understood that you can own a business without controlling the day to day operations and vice versa. In small and medium size businesses the ownership and control are often linked to Income too. Having the support of a trusted advisor, who has been through ownership transfer, means you and your business are both looked after throughout the planning and implementation process.
According to the Institute of Family Businesses, there are 4.8 million family businesses in the UK, which generate over a quarter of UK GDP and paying more tax in 2017 than the annual NHS budget. They also contribute to over 50% of private sector employment. Yet in the PWC Family Business Survey only 41% have any planning in play for the biggest intergenerational transfer of wealth in the history of the world. With only 4% of family businesses surviving to the 4th generation, this is a challenge that needs to be addressed.
What Is Succession Planning?
Succession planning is often associated with getting the right people into your organisation. In wider terms it’s about every aspect of the business from the people through to the numbers and the processes. Succession Planning is about making the business less reliant on the current business owner and more resilient for the future.
In small and medium size businesses there is often greater control held by one or two key people within the family and most closely linked with ownership at the same time. Recognising that just because you own a stake in the business doesn’t mean to have to (or should) work in it or control it is one of the key aspects of succession planning. It can be very liberating for the next generation to know that they don’t have to work in the business, doing something they aren’t good at or don’t enjoy, to keep ownership. Equally maintaining ownership means letting go of the day-to-day running of the company and that can be a challenge of mindset.
One of the keys to successful succession planning is writing the plan down and communicating it to everyone affected. Many business owner has a plan in his or her head – the magic happens when it’s clearly documented and communicated so that everyone else can see their place, role and responsibility in it.
Why Don’t Business Owners Plan?
Business owners spend more time working on the day to day aspects of their business, which means they are often reacting to situations and fire fighting rather than being proactive. It’s not just family businesses, it’s businesses in general. Yet evidence points to planning being extremely valuable – 1 hour of planning is worth 10 hours of doing – and can save time and money in the long run.
With Succession Planning specifically I often hear “it’s too early” or “I’ll do that when I’m ready to retire”. For the younger generation it’s often not knowing how to bring up the inevitable issue of death being the absolute certainty that needs to be addressed. Over 50% of business owners exit their business because of an unplanned event, often leaving their family picking up the pieces at a time when they are least equipped to do so.
Another key issue is conflict. The heir-apparent may not be the best person to take the reins or may not want to. So who becomes the next in line? This is where separating the ownership of the business from the control of the business is essential.
Finally there is a lack of awareness on the options available to business owners about transferring the ownership. There are also tax implications on each strategy. What are the options for keeping the business in the family?
- Outright gift
- Recapitalisation into voting and non-voting stock
- Transfer into a trust
- Bequest in a will (transferred at death)
- Sale in instalments
- Pre-agreed buy/sell agreement (also known as business will and used in conjunction with a number of options)
- Employee ownership options
Here’s a quick overview of the options:
Where the business owner is not funding their retirement from the sale proceeds, gifting the business ownership is easy but has complex and specific tax rules that can make the process protracted – specialist tax advice is always recommended. This does not address issues of business control i.e. who works in the business which is often the biggest challenge for a family company.
If losing control of the business while you are still alive is a primary concern, then generating new shares with different voting rights is one way of quickly resolving the problem. As the next generation becomes more capable of taking on the control of the business the shares can be converted from non-voting to voting shares. Ownership transfers over a period of time and can be for a sale price which allows the current owners to create a fund for their retirement. Control transfers at a different speed. The shareholder agreement sets out the rules for ownership and dividends can be set in detail through this mechanism. It can also be used in conjunction with a Buy/Sell agreement.
Transfer the Company into a Trust
Trusts are often seen as the tools of the aristocracy and uber-rich but they are a great means of keeping the family’s assets together and defining the beneficiaries for generations to come. They are particularly useful when there is no next-generation leaders coming into the business. There are many types of trust and advice from an experience trust lawyer is essential for you to get the outcome you desire.
Having a will makes life after your death a lot easier for your loved ones. It’s amazing how many business owners (and people in general) do not have a will. Seeking the advice from an estate planner means you will be able to manage your estate tax efficiently for everyone. If you only do one thing, please do this – if not for yourself, for your family.
A business is often the biggest value asset of an individual and in about 80% of cases it’s the main “pension fund” for a business owner. Yet more than 50% have not considered how to extract the value to fund their next phase of life. An outright sale may be beyond the means of individuals. Funding for such a purchase is becoming easier through new types of lenders to the market but is still a rarity (and the buyer may not be credit worthy). Selling in tranches means a gradual transfer over time. Another option is to become the lender and use a series of ‘loan notes’ between you and the buyer. In this way the business can become the source of funds for the buyer to acquire the business.
Of course new “owners” need to have the capability to generate profits and cash to adequately fund the future transfer and give an on-going income. They need to be able to succeed otherwise the “sale” won’t be a complete success. Part of the transfer timetable may include training and support.
There are advantages and disadvantages to this route and it requires careful thought as to how any changes in circumstances are handled (such as death during the transfer process). A good lawyer get the right structured deal documented to protect everyone involved.
Buy-Sell agreements are legally binding contracts that show how the sale of shares occur in certain events i.e. death or disability of the owner. They are often called business wills and are used in conjunction with shareholder agreements. They are designed to protect all owners and the business, reducing the adverse effect of unplanned events.
Often a buy-sell agreement will stipulate the valuation method and a mechanism for funding the purchase of shares. This avoids the need to liquidate a company, which can happen when tragedy strikes.
Employee Stock Ownership Plans (ESOP)
Employee ownership is a big subject and comes in many forms from options through to outright ownership of shares and Employee Ownership Trusts. To find out more please see our white paper – https://successionplus.co.uk/employee-share-schemes/
ESOPs are a good succession planning strategy when a privately held company does not have a clear family member successor or a management group to purchase the company. ESOPs can be a win-win situation for business owners looking for a tax-efficient succession plan, as well as for employees, who can share in the upside of the company’s appreciation.