Passing a business down through the generations – without rancour

Peter Shand

Hard as it might be to accept, there inevitably will come a time when the owner (or owners) of even the most successful family businesses has to ‘let go’. But doing so is not simply a choice between closing down, selling out to a competitor or passing ownership to close relatives, in most cases sons and/or daughters or younger siblings. The business needs to be so structured, preferably in advance, so as to allow the right people to take over the running of it, either on death or during lifetime of the owner.  Succession planning is crucial to this aim.

Trusts are often looked at as a way of ‘grandfathering’ the business out of the direct control of the original owner but still allowing him or her to retain some influence and oversight over the  assets and their management.   Trusts can be set up with a number of trustees who exercise discretion over the business objectives and succession planning and this can allow long term views to be taken.  This is a useful way of postponing vital decisions which the owner is not yet ready to make but at the same time wants to start the succession ball rolling. 

It is certainly good for proprietors to open a dialogue with family members and their advisers and start forward planning as they reach retirement. While in some cases a business owner may pick out a particular family member to take over all or part of the enterprise, decisions should be part of an overall estate planning process, to avoid any family disputes or bitterness in the future. An individual who has established and grown the business over the span of his career is unlikely to want to hand everything over in one go.  There are, in many cases, ways to structure the transfer of ownership to allow for a transitional period and a staggered release of control. 

One of the worst case scenarios is where no thought has been given to the succession of the business before the death of the owner and the assets might end up passing under an unsatisfactory will (which may or may not have been drafted with the succession of the business in mind). Worse still, there may not even be a will, in which case the general laws of succession come in to play, potentially leading to serious disagreement, some of it quite unpleasant, among family members and even long term bitterness from which the business may not recover.

Another possibility is that, rather than death, mental incapacity or frailty will affect the owner, also leaving the business in a state of inertia. Restructuring after the event is not without difficulties and can be expensive to sort out and, again, there may be disagreement among the family members as to what should happen.   Also, when a business is struck by the death (or incapacity) of the owner, consideration needs to be given to the position of any widow (or widower) and his or her continuing involvement, personal reliance on profits or liability for business debts.   The will needs to be drawn up so as not to conflict with the provisions of the company’s constitution (e.g. Memorandum and Articles of Association, or Partnership Agreement). There are likely to be specific provisions in the governing document of the business which set out what is to happen on the death of the owner. 

For example, there may be cross options included within the Articles of Association which given certain family members and/or other stakeholders pre-emptive rights to take up shares or interests in the firm.    These need to be taken into account.

In the run up to the sale of a family business, all professional advice tends to be focused on corporate tax aspects of the sale, asset valuation and the exit strategy, including the structure of the sale and heads of terms (including share sale versus asset sale, the possibility of pre-sale dividends, ‘earn-outs’ and the possible issue of loan notes).

As a result, it is easy to forget about the position of the business owner as an individual which is likely to change dramatically after the sale takes place.   From a tax perspective, he or she is “protected” against Inheritance Tax to the extent that the business may qualify for Business Property Relief.   Post sale, however, (and in the event that the business is effectively converted to cash), Inheritance Tax liability on death may become a concern.  

The point here is that, quite often, in the run up to any business sale, there are some initiatives which can be taken from a private client tax planning perspective that can be used to soften the blow of the loss of Business Property Relief and also allow for succession planning. The principal objective for many who find themselves in this situation is to pass wealth down the generations – and do so without rancour.  

PETER SHAND is a partner with the Edinburgh-based law firm, Murray Beith Murray   [email protected]