18 FAQs people ask about passing their business onto their family
Most people find that it takes at least a couple of years to prepare. Although it is possible to pass a business on at short notice, it can take several years to handle activities such as grooming your successor effectively. The sooner you can discuss your plans with your advisers, the better.
Areas to consider include:
In many cases, passing the business on to your family is as much a matter of personal preference as a commercial decision. Nevertheless, it is worth thinking about the possible commercial implications.
Passing ownership of the business to your family can avoid much of the expense and disruption of other forms of sale - for example, a trade sale to wholly new owners. However, a reluctance to involve external investors may constrain the business's ability to grow. Retaining family ownership may also mean that the family's investments are heavily concentrated in the business, leaving the family at risk if it runs into problems.
As far as management is concerned, the overriding concern is whether any family member is both interested and has the right skills and experience. Even then, keeping management in the family can lead to a narrow-minded outlook and lack of ambition. However, family managers will understand the culture of the company, and are often good at taking a long-term view of what is best for the business.
Purchasers may want to defer part of the payment. Clearly this puts you at risk of the purchaser becoming insolvent during the interim period. However, accepting deferred payment may increase the price purchasers are willing to offer, and can be a useful part of your own tax planning. You should ensure that you negotiate suitable security for any deferred amounts.
Along with deferred payment, buyers sometimes wish to negotiate an 'earn-out', where part of the price paid is based on the future performance of the business. Again, this exposes you to risk - if the business underperforms - but may increase the price the purchaser is prepared to offer. It is common to negotiate your continued involvement in running the business as part of any earn-out arrangement. Such provisions need careful drafting to ensure that the business has the best possible chance of meeting its targets to ensure the anticipated price is achieved. Careful consideration needs to be given to the tax consequences of such an arrangement.
Purchasers may wish to use shares in their company to pay for the purchase. In effect, they are asking you to swap your shares in your company for shares in their company. If so, you will need to establish how much those shares are worth to you. Accepting a minority shareholding in an unquoted company can be risky. You will need to check their company's articles of association to see what rights the shares give you, and for any restrictions on sale of the shares in future, and may want to negotiate a suitable shareholders' agreement. Otherwise you could find that you have no control over how they run their business, are unable to sell shares when you wish to, and cannot obtain a good price for them.
In practice, many businesses are passed on when the owner decides to retire - many owners are unwilling to give up ownership and control before this. A more flexible approach takes into account when you expect your successor to be ready to take control of the business. Also, tax planning considerations may make it advantageous to transfer ownership of assets sooner rather than later.
The most common option is to share ownership by giving each child shares in the company. An appropriate shareholders' agreement will help clarify how the business is to be run and minimise the risk of conflict. Where several children want to take an active role, or family members have different views on the future direction of the business, an alternative may be to split the business into separate companies. This avoids the complications that can arise when family members manage a business together.
Be wary about splitting management responsibility between various children. You can, however, split ownership: for example, by giving each child shares without dividing management.
Prepare (or update) a shareholders' agreement. Talk through all the key issues such as what the company's business strategy will be. Ensure that the discussion covers ways of resolving disputes and what will happen if one of the children wants to sell out of the business. If the other children will have to buy those shares, consider how they will be able to afford them.
Think also about the potential for conflict between children who work in the business, and those who only own shares. You could choose to give them different rights. For example, the children who will run the business could have voting shares, while others had non-voting shares but with preferential rights to dividends.
In practice, children who work for the business may be at an advantage: for example, if they are overpaid for their work, or if they have disproportionate control of decision-making. (In some instances, the opposite is true.) The most straightforward way to avoid this is by using a suitable shareholders' agreement. Amongst other things, the agreement can include that family members will be paid and promoted on the same basis as other employees. It can also include measures to protect the rights of family members who control a minority of the voting rights.
You may want to find an interim successor, with a view to passing control to your child later. If so, it's best to be open about it. The interim successor is likely to find out anyway, and may be able to plan more effectively if they know what timeframe is available. You will also want to ensure that the interim successor's contractual arrangements reflect your plans. Of course, some potential successors may be unwilling to take on the role in these circumstances. In terms of ownership, you may wish to transfer assets even if you are not yet ready to transfer control: for example, if you are concerned about possible Inheritance Tax. If you feel that your child can't yet be trusted to make the right decisions, you might do this by issuing non-voting shares, or by placing assets in a trust. This is a complex area where advice is essential.
In a company, directors are usually nominated by the board of directors and approved by the shareholders. The mechanism will depend on the company's articles of association, and any shareholders' agreement. If you own a majority of the shares and you control the board, this means that you will be able to nominate whoever you like as your successor.
You can retain control - for example, by retaining a majority of the voting rights. However, this is rarely a satisfactory solution, as your successors are likely to resent your interference.
A more practical approach is to discuss your wishes with your successors, and agree what values you want to see retained. These can be enforced either through a shareholders' agreement, or by amending the company's articles of association.
Be wary of limiting the business's ability to react appropriately as circumstances change in the future.
Try to understand what skills and experience will be most valuable to your successor. The strengths that enabled you to build up the business may not be what your successor needs to take it forward in the future.
A common approach is to have your successor work in different areas of the business to familiarise themselves with it all. It is also often a good idea for your successor to get exposure to new ideas and different ways of doing things. This can be accomplished by working for another business, and through suitable training.
It's usually helpful to work towards a planned handover date. During the final month or two, your successor can work alongside you. You can also use this time to ensure that they have all the information they need, and have been introduced to all the key contacts within and outside the business.
It's a good idea to involve everyone who has an interest in the business, including any other shareholders, major lenders and key employees. By talking your plans over with them, you stand a better chance of convincing them that the appointment is in their interests and overcoming any concerns they may have.
Potential problems include:
All of these risks can be reduced by planning in advance and taking suitable advice. As with any other major change, involving key personnel from the outset can help to reduce problems.
It may well be a good idea for you to stay on as an adviser, but on the basis that you give advice only when asked for it. Otherwise both your successor and employees become confused about who is really in control, and the business suffers.
If you have been a director of a family company, this approach would normally mean that you resign your directorship. You should bear in mind that if you continue to exert an influence through the other directors, you might be considered a 'shadow' director of the company. If the board of directors subsequently faces a claim (for example, for 'wrongful trading', which is when the directors carry on trading through the company when they know - or ought to have known - that there was no reasonable prospect it could avoid becoming insolvent) you could also be held personally liable, because you are operating as a shadow director, to contribute to the company's debts.
Retaining a financial interest can cause problems, particularly if the business represents a significant proportion of your capital (or generates a significant proportion of your income). Not only will you be at risk if the business runs into trouble, but you may find the temptation to try to interfere irresistible.
Depending on your personal financial assets, and the financial position of the business, it may be possible to provide adequate security for your spouse regardless of the business: for example, through suitable investment, pension and life insurance arrangements. Alternatively, you may want to use an appropriate form of trust. This can be structured so that your spouse benefits during his or her lifetime, but the children are able to manage the business in the knowledge that they will benefit thereafter. This is a complex area, not least in terms of taking into account the potential tax consequences, so expert advice is essential.
Options can include selling shares to existing or new investors, selling shares back to the company, paying dividends to shareholders, or making payments into your pension fund. Depending on the business' financial position, it may make sense to increase business borrowings to fund these payments. It may also be appropriate to sell part of the business or some of its assets. You should take advice on the tax consequences of the different options and the best choice given your circumstances.