Against the sands of time

No-one is immortal. But companies are different: they can live forever. Take mobile giant Nokia for example, which began life as a pulp mill in 1865, while Colgate-Palmolive and DuPont are also more than 150 years old, and still going strong.

Browse through a list of prominent family businesses in the UK and even older examples stand out - wine merchants Berry Bros & Rudd (founded in 1698); hatters James Lock (1676);
and private bankers C. Hoare & Co. (1672) - all are still owned and part-managed by the original founding families.

A Barclays report, 'Family Affair: Spotlight on UK Family SMEs', found that family businesses contribute £180bn a year to the UK economy, with some boasting very impressive turnovers.

Despite this success, only around
30 per cent of family businesses in Britain survive into the second generation. One factor behind this low figure can be a reluctance to tackle the issue of succession planning at the right time.

When looking to pass on a successful family business, failing to plan for succession can have multiple adverse effects. Much therefore depends on thinking ahead and acting accordingly
to preserve the business.

Its continued longevity requires careful transition planning, as does the potential sale of the business, particularly if a surviving spouse or child do not wish to continue operating the business as directors or managers, once the founding entrepreneur has gone.

Family business owners should therefore be asking the following questions:

• When is the business going to be passed to the next generation?;

• How do we ensure the next generation are ready, or even want to be involved?;

• What structure best suits the chosen transition?; and

• What issues need to be avoided and how do we avoid them?

Passing on a business to the next generation presents many challenges. Generational transition, alignment of family interests, buyout issues, potential disputes, and inheritance tax.

Make a will

Whatever the owners chosen method of doing this, the first and most obvious step for any business owner is to make a will that fully anticipates what will happen to their interest in the business when they die.

When it comes to the fate of the business itself, the following should be considered.

An outline of defined objectives

If a succession plan already exists, its effectiveness should be reviewed periodically to account for changing circumstances and legislation.

If it does not, a strategy needs to be developed stating exactly what will happen to the business. Where appropriate, this should identify the nature and scope of the continued family involvement in management and ownership of the company, or possibly allow for bringing in professional management to secure its future operation.

A clear succession plan

The decision-making process should involve relevant family members who are to inherit the business. Communication is key - failure to speak with the next generation is one of the biggest reasons why family businesses don't survive.

Once settled, the plan should be documented in writing and communicated to them. It should identify the successors - managers and owners - and the active/non-active role for each relevant family member.

Business property relief

Spouses are automatically exempt from inheritance tax (IHT). Under the UK government's business property relief (BPR) for IHT, trading businesses also qualify for 50 per cent or 100 per cent exemption on some, or all of an estate's business assets.

These can be passed on while the owner is still alive, or as part of the will. This then allows a family business to be passed on without any tax applying. To qualify, the business must be an unlisted company, which has been trading for at least two years.

Discretionary trusts

When writing a will, one preferred option is to leave the shares in the business to family members other than the spouse, most especially children. Frequently, this is done through a discretionary trust, where both the surviving spouse and the children are typical beneficiaries.

If a discretionary trust is
established, inheritance of the shares
is predetermined, ensuring that the
estate, including the family business,
is tax efficient. If there is a need for the business to pass outside of the family (say to a management board who are not members of the immediate family) then it is sensible to consider cross option agreements (COAs).

Suitable insurance can also be drawn up at the same time, allowing trusts to be incorporated using all available tax allowances and maximising IHT savings.

In practice, this means that the business can afford to buy the shares back from the beneficiaries of the deceased partner's estate, while retaining the shares without any loss of control. At the same time, the deceased's family will receive a fair market value of the shares.

Shot yourself in the foot?

Nevertheless, failure to plan ahead can lead to a variety of problems in transferring a family business, even when the necessary structures have been put in place.

While most business owners may think that their estate will automatically qualify for BPR, some beneficiaries find that IHT does apply because of changes made to the business structure after the plan has been implemented - for example, making a decision to incorporate, while leaving the ownership of the business premises outside the limited company.

This can lead to a liability for IHT, as can having the activities of a business split into more than one company where the assets of the businesses are not properly structured in a holding company.

Problems also arise with disputes between beneficiaries.
Indeed, some of the largest litigation in the world is between beneficiaries of family businesses once the founding entrepreneur has died.

A prominent example is the protracted battle over the estate of the late Y C Wang, a Taiwanese billionaire. Wang died in 2009 and his $15bn estate (mostly in Bermuda trusts) has been the subject of a continuous fight in the courts between his widow and several of his ten children.

Disputes between living partners in a family business are another fact of life. Couples who run a business together sometimes run into serious difficulties; divorce has inevitable consequences. Parents and siblings may also fall out. Where co-ownership of a family business is involved, this can prove to be highly problematic. If succession planning is already in place, it might need to be quickly revised.

Review periodically

And that message is key: once a succession plan has been implemented, be prepared to change it if necessary, according to circumstance. Make regular reviews and update the plan where appropriate to respond to changes in legislation or family dynamics, and think carefully about how the operation of the business and its assets are arranged so as to be tax efficient.

Above all, the client must be prepared. Do nothing and problems are guaranteed. Every family business should have succession planning in place once it reaches a level of maturity and profitability. None of us live for ever. But in the right hands and with the right planning, a family business just might.

Suzannah Farnell is a director of Progeny Private Law