Passing on a family business

Who will run the empire when you’re gone – or at least sunning yourself on your private island? EN examines the best ways to protect your wealth when passing on the family firm.

1. What’s it all about?
The family firm was no doubt started to earn a daily crust but, as succession approaches, you need to ask some deeper questions.

Is your business solely about creating income and asset growth for the family? Is it there to provide a fruitful career to your capable offspring? Is it a soft career option for your not-so-capable offspring? Is it about creating local jobs?

How you and your potential successors view the business – and what it should be longterm – will influence what you want from passing it on.

2. Maximum relief
From a personal perspective, you’ll want to know how to extract capital from your business when you hand it on. Tony Medcalf, a tax partner at chartered accountant Moore & Smalley, says your firm may need to sell assets or borrow so you can withdraw funds, so it’s “vital” that you examine the most efficient options for dealing with capital gains tax, like entrepreneurs’ relief.

“The relief gives an effective rate of ten per cent on all gains up to £10million, as opposed to the previous limit of £1 million for gains before 1 April 2010,” he explains.

“With gains over the lifetime limit being charged at the new higher rate of capital gains tax of 28 per cent, entrepreneurs’ relief makes it easier to get the level of income you want from the sale of the business.”

Irene Wolstenholme, senior tax manager at private bank Coutts, adds that an enterprise must be a “personal company” to qualify, whichmeans you must have owned at least five per cent of its share capital and have worked in the business as an officer or employee (although not necessarily a full-time one).

“If you pass on a business by giving it (or shares in it) to someone else, you also have to consider capital gains tax,” she notes.

“In theory, unless the recipient is your spouse or civil partner, you should pay capital gains tax based on the value of the shares at the time of the transfer. However, where a personal company is involved, you can usually agree to elect to hold over the gain. This means that capital gains tax is not paid at the time of the gift, but on the whole of the gain when the recipient disposes of the business.”

3. Passing on after passing on
Kicking the bucket while still at the helm would be a trifle inconvenient, but at least you could recline on your cloud in the knowledge that inheritance tax rules for a trading business are pretty generous.

Wolstenholme says that if the deceased has owned an unquoted trading business for at least two years, its value is excluded from their estate for inheritance tax purposes. There are also exemptions for company land, buildings, plant and machinery.

“For example, business property relief (BPR) for inheritance tax is available at 100 per cent or 50 per cent on interests in a trading company, so it can be a very valuable relief to qualify for,” says Elaine Roche, a partner in wills and estate planning at solicitors firm JMW.

“However, many businesses have company articles in place which provide for shares to be sold immediately on death, which stops BPR being available. A simple cross option agreement can be put in place to ensure BPR can be claimed.”

Paul Hyland, tax partner at chartered accountant Duncan Sheard Glass, notes that if both parents are owners, it could be possible to get 200 per cent inheritance tax relief, as well as a tax-free uplift in the capital gains tax base cost if the shares are held until death.

“While this might not be ideal for children who want ownership, especially considering longer life expectancies these days, this would also save tax on any future sale of the company,” he says.

Laura Hutchinson, senior personal tax consultant at Royce Peeling Green, and David McKendrick, director of RPG Consulting, stress the importance of the majority shareholder having a will that stipulates their intended heir.

“Otherwise they will pass under intestacy and this often wastes the 100 per cent inheritance tax relief available on the shares,” they add.

Meanwhile, Lee Dinsdale, a private banker at Barclays Wealth, says a carefully drafted will can also achieve efficiencies by ensuring fully relievable assets go to “chargeable beneficiaries” such as children, grandchildren or trusts, rather than a surviving spouse.

4. Family trees: Mind the splinters

If you’re part of the second or third generation to run a business, its shares may be spread among a few relatives. So what do you do if distant Cousin Eddie checks out while holding a significant slice of the pie?

Paul Bricknell, an associate at law firm DWF, says that a shareholder agreement can help to keep the business in the hands of those with an interest in running it.

“Shareholder agreements may confirm that only family members working in the business can own shares,” he says.

“However, upon the death of a working shareholder with no immediate descendants that work in the business, the remaining working shareholders will be expected to purchase the transferring shares from the deceased shareholder’s estate at fair value. They may not, however, be in a financial position to do this.

“One solution may be taking out life insurance on each shareholder’s life.

This could allow the fellow shareholders to buy out their shares on death. This is very common in a nonfamily business scenario, but families often don’t see the benefit in the cost of insurance.

“However, the reality is if the family is to ensure that shareholdings don’t become fragmented, insurance may be the best solution.”

5. Incapacity – who benefits?

Succession planning isn’t just about pondering your own demise. You should think about permanent incapacity too.

Hutchinson and McKendrick say that business owners should register a Lasting Power of Attorney (LPA) designating who will act in their place.

An LPA, Roche notes, can be limited “solely to business decisions or can apply to the whole of someone’s property and affairs”.

“Without one in place, an application needs to be made to the Court of Protection to deal with the person’s assets,” she adds.

6. D-I-V-O-R-C-E
Dr Allan Discua-Cruz, a lecturer at the Institute for Entrepreneurship and Enterprise Development at Lancaster University Management School, says passing the torch to the kids, and the kids’ kids, creates new “structures” that can complicate the succession process. There could, for example, be “several children wanting to take the company in different directions”.

According to David Pickering, national head for private clients at DWF, these changing structures can bring their own wealth management headaches –such as the “very real concern” of what happens to the inherited assets of a son or daughter who subsequently divorces.

“While wealth can never be absolutely safe from divorce claims, there are steps parents and families can take to mitigate the risk,” he says.

“Pre-nuptial agreementsbetween the marrying couple can allow for gifted assets to be ring-fenced from divorce. Also, loaning rather than gifting monies can make it more difficult for it to be divided up in divorce proceedings, while creating a trust for inherited wealth to be held under the management of trustees can protect it from the risk of a claim against the asset.”

7. Trust issues
Trusts are not just for protecting the family wealth against wedded bliss gone awry. They can also be a good way of showing appreciation to your other half for their patience and stoic support.

“By focusing your efforts on passing the business on to your children, there is the potential for your spouse to be overlooked,” says Medcalf.

“You may want to use an appropriate trust, structured so your spouse benefits during his or her lifetime, but the children are able to manage the business in the knowledge they will benefit later.”

Trusts also let you retain a degree of control when giving up the company hot seat.

“Trusts are useful vehicles to pass the benefit of the shares to the next generation while the donor retains control as trustee, both of the voting rights and also of the timing of distributions of the dividend income or the shares themselves,” say Hutchinson and McKendrick.

“Alternatively,” says James Thompson, associate director at financial services group Taylor Patterson, “‘alphabet’ shares can be created, which have different benefits and rights, relating for example to voting or dividends, to ensure that the right elements are in the most suitable hands.”

8. Step back
You can tinker with trusts, write wills and tax plan until the cows come home but it’s unlikely anyone’s wealth will benefit if the family firm goes to somebody who doesn’t want it. The last thing you need is your anointed heir ditching your poetry business to become a miner.

Discua-Cruz, himself a thirdgeneration family business member, says succession can be “quite an emotional experience” and while it is the owner’s prerogative to decree that the business be handed to their son, regardless of what anyone else says, it pays to be honest about who is best suited to the job.

“Being a relation of an existing business owner is not in itself a qualification and the retiring business owners should be confident the incumbent directors have the aptitude and experience to successfully
continue the business practice,” says Thompson.

It could be worthwhile, therefore, to involve trusted senior staff in choosing a successor and perhaps even relying on their experience and managerial know-how to carry the company until junior is ready to take over. But remember, cautions Discua- Cruz, you will eventually have to relinquish command.

“One of the key ingredients is that the successor must be committed and willing to take over and, at the same time, the founders must acknowledge it will perhaps be at the successor’s discretion whether they take the family firm where the founder’s dream was – and it might not happen that way,” he says.

9. Charter course
When you do hand over the reins you need to be crystal clear about your future role. “Stepping down is one of the hardest things to do in business and this can cause problems if the successor feels there is too much interference,” Medcalf comments.

“This can be a particular problem where the person passing on the business retains a significant shareholding and is therefore still financially dependent on its success.

However, if your successor can’t assume their role freely, this is likely to lead to frustrations and the business may suffer.”

One way to set a general course without constantly looking over the new captain’s shoulder (which would make you the parrot? -ed) is to draw up a family charter.

“A family charter is similar to a shareholders’ agreement, governing the composition, running and ownership of a business,” says Pickering.

“They usually also contain a general statement about the family’s vision for the business in the hope that this will help guide future generations.”

In addition, a charter can bring clarity to the tricky “balancing act” of treating all family members fairly while rewarding those who have driven the business forward.

“Across the globe, it is estimated that just five per cent of firms survive until the fourth generation,” says Coutts family business partner Paul Andrews.

“In order to achieve long-term success, family businesses need to have a clearly articulated vision which all family shareholders can both understand and buy into – and they need to make sure family goals are aligned with the business.”

10. Family planning
Colin Lawson, managing partner of Equilibrium Asset Management, says that planning –and planning early – is essential if you want to avoid a financial and emotional rollercoaster.

“Have a plan in place as to when you would like to exit and work towards it,” he advises.

“Don’t just expect your heirs to take over at the drop of a hat; it’s best to start phasing yourself out of the business over a few years.”

“The earlier you start to think about the future, the more options there are available and the more tax can be saved,” Roche adds.

Dinsdale says that the original business plan will ideally include an exit strategy that can be tweaked as the company evolves. If yours doesn’t, now is the time to ponder it, even if you’re years away from the pipe and slippers.

“Don’t wait until you’re dead,” Discua-Cruz warns. “It’s actually a process that takes time and a lot of it will relate to training and preparing the people that you think will be the right successor.”

Andrews says you also need to think about family members with “short-term financial needs, or who don’t support the company’s long-term vision”. The savvy owner will factor in a way for them to “exit fairly and harmoniously from the business”.

On a personal note, says Lawson, you’ll want to ensure there are sufficient funds for you to ride off into the sunset, as well as a clear structure for taking your well-earned wonga.

Ultimately, family, management and staff need to understand and support the longterm strategy. Which really brings us back to the question, what is the business for?

“This is a process that goes in different ways for every family,” says Discua-Cruz.

“In some family firms, it may be a very smooth process. In other ones, it may be a very fragile, very emotional process.”

“Education is key to prepare the next generation of shareholders to become a cohesive and responsible group of beneficiaries and to understand the responsibilities of being owners as the business passes down the generations,” says Andrews.

“The earlier they can start, the better.”

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