Running a business can be all-consuming and, for many business owners, “firefighting” would be a common description of the working week. It’s no surprise that for many of them, thinking ahead to a formalised exit strategy is often neglected.
Succession planning is difficult enough without the curve balls that life can throw at you. With family businesses, adding an emotional dimension to the mix and can be a recipe for disaster.
Small and family businesses continue to play an important role in the UK economy. However, many of them are completely unprepared for the transfer of ownership from one generation to the next, or indeed to a third party. Over half (58%) of family-run businesses in the UK do not have any form of succession plan in place, according to Legal & General. This matters because they are missing out on unlocking the true value of the business they created.
Andrew Hall, Director, Wealth Management, Barclays Scotland, said: “Too often we can be preoccupied with creating wealth and the preservation of those finances becomes an afterthought. However, by having a structured approach to succession planning you can facilitate and ensure the perpetuation of those funds to your loved ones.
“We have all seen and heard of cases where those who have not implemented a clear succession plan have, in the face of a major life event, run into major difficulties with the family business and estate, leading to dispute and even litigation with close family members and more distant relatives. The cost of taking no action can be severe.”
Disputes between family members in the business
To an outsider, a family-owned business may not look that different from any other. However, because they tend to be characterised by the interplay between individual family members and their relationships on the one hand, with the commercial interests on the other, succession is often more complex.
“A frequent problem is the frictions that can arise when the owner passes on his shares to those members of the family who already work in the business,” commented Stuart Duncan, Partner and family business specialist at Davidson Chalmers LLP. “This can cause resentment and even hostility among other members of the family who are not involved in the business.”
One solution is for the owner to assure those family members that the apparent inequitable situation will be rectified posthumously in their will. An alternative and often effective solution is for the owner’s shares, at the time these are transferred to the family members, to be split into two separate classes, with one class (for those family members not involved in the business) having restricted voting rights, and the other (for those engaged in the business) having full voting rights.
Stuart explained: “Both classes would have full rights to income and capital, thus ensuring financial equality, while at the same time ensuring that those family members running the business are left to get on with it without undue interference from those who are not involved.”
Another key succession issue is whether certain members of the family have the skills necessary to drive the business forward in the absence of the owner.
“Preparing a focus document or family charter which is not legally binding, but sets out the aspirations of how the business should be taken forward post-handover can help overcome this problem,” Duncan added.
No one wants to fall out with family but disputes are all too common. You need a strong shareholder agreement and a mechanism for dispute resolution that is formalised and documented. Involving a Non-Executive Director whose opinion is widely trusted and valued, or a third-party adviser, can help.
“They can direct discussions and mediate if issues arise,” agreed Ian Macdonald, who is head of Private Client at law firm Wright, Johnston & Mackenzie and represents Scotland on the Council of STEP, the Society of Trust and Estate Practitioners.
Failure to discuss issues openly and frankly
Death and taxes may be the only sure things in life, yet owners’ reluctance to plan ahead is often a result of not wishing to acknowledge their own mortality or having a fear of retiring without a proper pension or income stream; or it’s simply that individuals are reluctant to pass on assets because they fear the money might disappear or the next generation might not do as good a job.
“Don’t assume that the next generation will want to take the business on,” Ian warned.
Alistair Main, Director of Duncan & Toplis, said: “To avoid problems, it’s important to work with the family to identify who is interested in running the company and who would rather have the capital out to use as they see fit. To manage a successful transition, you have to manage everyone’s expectations and aspirations and make sure that there’s clear and open communication between all the stakeholders.”
Andrew Hall added: “We find that starting a dialogue and interacting with the family early on can reduce disputes when stressful circumstances arise and can often lead to greater engagement with the younger generations.”
A more formal structure for family meetings, such as a family council, can pay dividends, noted Andrew Wilkinson, a Partner at law firm Shakespeare Martineau. It “forces people to address issues head on”.
The ensuing plan should cover matters such as the timing of the handover, which could be phased, the extent of the owner’s involvement after the fact, and financial arrangements such as the payment of a consultancy fee or other considerations for the transfer of shares.
Out with the old, in with the new?
Bringing fresh blood into an established business has its advantages, but it’s not without its risks, warned Helen James, Corporate Finance Partner with HW Fisher.
She said: “The chances are that the younger generation will bring new energy and quite possibly a new strategy to the business. But the older generation has experience that you certainly wouldn’t want to throw away just like that.”
Be mindful too of the risk of losing key employees and the impact on supplier and customer relationships, which are often tied up with the founder of the business. Accountancy firms are a good case in point, where the relationship between partners and clients often means that the loyalty is to the individual partner rather than to the firm.
In owner-managed businesses the question is: are you as good as the previous generation at maintaining relationships and developing new ones?
“It’s not just about passing the baton,” commented Simon Renshaw, Director and Insolvency Practitioner with AABRS.
Ian Macdonald advises having a formalised policy for employing family members in the business so they can learn the business, rather than being parachuted into the top job. The latter route is almost guaranteed to unsettle existing employees and put noses out of joint. The transition from old to new needs to be thought through and managed carefully.
“It’s about making sure those personal relationships are passed on slowly,” Helen explained. “Have a slow handover period to allow new people to ingratiate themselves with clients.”
The ongoing war for talent
The ability for family businesses to attract and retain the skills needed throughout their business is now the sector’s number one concern, according to the KPMG Enterprise European Family Business Barometer published in December last year.
“Without the right skills in a business, it will struggle to deliver on its potential and to grow in a competitive market,” explained Kirsty Ross, Family Business Consultant with KPMG.
Around four in 10 of the family businesses surveyed named recruiting skilled staff as one of their business’ major issues – ahead of increasing competition and declining profitability.
Kirsty continued: “The culture and values that become apparent to employees within many family businesses, once they have joined, means they tend to perform strongly when it comes to retaining talent. However, as their appetite to tap into skills existing outside the family gene pool grows, in a high employment economy, the experience of the war for talent intensifies as they compete to attract staff with sought after skills.”
Given that most (87%) of the businesses in KPMG’s survey are committed to maintaining family ownership, and have a potentially wide pool of relatives amongst whom to share dividends, the remuneration packages on offer to attract talent can be more limited than with other ownership forms if share schemes and option plans are not available.
“It’s therefore important that they effectively build and communicate their value proposition as an employer; what it means to be a family business and why it’s a good thing to work for one,” Kirsty added. “This might include their commitment to staff and communities, and be demonstrated by tangibles such as higher levels of investment in training and corporate responsibility, as well as relatively fewer redundancies during tougher times.”
Incurring an unnecessarily large tax bill
People think that tax might be an issue when it comes to succession planning but that’s not necessarily the case, according to Ian Macdonald. The tax implications of any succession plan must be considered, but the good news is that the UK tax system for transferring business assets or ownership of a business is fairly benign.
A business owner can pass on their business free of tax when they’re alive or after their death, but only if all tax reliefs are claimed. Business relief exempts business assets on 50% or 100% of inheritance tax, and holdover gift relief can exempt business assets, including certain shares from capital gains tax (CGT) when they’re given away.
The rules are not always obvious, so it’s vital to check that tax reliefs for the transfer of business assets are available. “Good advisers are essential in steering business owners through what can be a highly complex area with serious consequences in getting it wrong,” warned Stuart Duncan.
The number of divorces in Scotland is continuing on its downward trajectory, with 8,875 dissolutions taking place in 2015/16. For business owners, though, the prospect of divorce can have succession planning implications and should therefore be addressed from the outset.
In Scotland, assets owned by either party before the marriage are not part of joint matrimonial property, but something like a capital restructuring could turn a business into a “new” asset, and thus a shared asset. Business owners should be aware of that and mitigate against the business unintentionally becoming part of the matrimonial “pot”.
There are ways of involving spouses in a shareholder agreement that would specify what would happen in the event of a divorce.
“You don’t want to, but it’s important to think about how you would protect business assets at the point you put together your shareholder agreement,” Helen James commented.
“The obvious answer is some kind of prenuptial agreement that sets out that the business will not be included in any division of matrimonial property. In Scotland, those agreements are legally binding as long as they’re set up properly,” Ian added. “But it’s not necessarily the fairest way to approach it.”
The crux of succession planning is to start the conversations early and to keep talking. “You have to think about it at times of major change in a family or a business, but there’s also place for an annual review,” added Andrew Wilkinson. “With family businesses, the tensions can be greater because succession planning is the elephant in the room.”