My finances, my projects, my life
August 11, 2020

How to manage succession in a family business

  Compiled by myLIFE team myCOMPANY July 26, 2018 85

There are many upsides to a family business. You can surround yourself with people whose motivation extends beyond share options and bonuses but are driven instead by the preservation of family tradition and loyalty. Those involved in the business may share a better understanding of its idiosyncrasies, having been involved from an early age, and will be familiar with clients and advisers. However, that doesn’t necessarily mean succession is easier.

Although the health and longevity of a family business may depend on an effective transition to the next generation, it can be just as difficult to cede control. There may be greater expectations despite fewer formal barriers. Familiarity may not breed contempt, but it can lead to fiercer disagreement.

It may be tempting to put off this complex decision until time forces your hand, but the long-term strength of your business will likely depend on working out your intentions and explaining them to affected stakeholders at the right time. That could well be a time when they challenge your decisions, however uncomfortable that might seem, and it helps to plan collaboratively. If there are people you envisage being involved in the business in future, you should check that your vision chimes with theirs.

Personal motivation

The first step will be to examine your own motivation, and ideally consider what you really want to do with your life. If a business has been your life’s work, will you really be able to walk away? Might you want to keep an active role within the business, and what would that look like? Can you cherry-pick areas that you favour, or clients that matter to you most? At the heart of this issue is whether you are genuinely ready for retirement. Whether you are or not, succession planning still matters – it will just take a different form.

The emotions of family relationships affect succession planning. (…) It is best that all are honest about their own attitudes and open about their intentions, however difficult that may seem.

The emotions of family relationships affect succession planning. Parents may have developed firm views on the relative talents of each of their children and their aptitude for running the family business – which may or may not coincide with the ambitions of the children themselves.

It is best that all are honest about their own attitudes and open about their intentions, however difficult that may seem. This can help reach a decision on whether it makes sense to promote a family succession, or explore the possibility of bringing in a third party. While a family succession could bring a level of trust and loyalty difficult for someone from outside to emulate, the approach limits the available talent pool even for the smartest families.

Separating management and ownership

Ownership and management of a business go together for entrepreneurs, but they do not have to stay that way. Your children’s legacy does not necessarily depend on their ability to manage the company successfully, and even if they are not the right people to run the business, that does not mean they have to surrender their economic interest. It usually makes sense to consider the running of the company separately from beneficial interests during the long-term planning process.

A key element is up-to-date information. It is vital to share any business problems or financial black holes with those who are liable to have to deal with them in future. You may have the skills and experience to manage problems, but your successor may not, and it could divert them from the central task of sustaining and building the business.

Ahead of any succession planning, you should ensure that three to five years’ worth of accounts are available and be willing to share them with anyone who may be involved in the business in future.

Ahead of any succession planning, you should ensure that three to five years’ worth of accounts are available and be willing to share them with anyone who may be involved in the business in future. This will allow them to ask any questions while you are still at the helm. If the plan is for a trade sale rather than a family succession, this will be a requirement anyway. The same is true for future projections and plans. High-quality budgets and forecasts offering a clear-eyed view of prospects for the future will help smooth the path of any successor.

Professional advice

Once this is all in place, you can start conducting the necessary conversations, which may be daunting. By definition, they involve relinquishing control of an enterprise to which you have dedicated much of your life, and imply a recognition of your own mortality. Involving an independent third party can help smooth this stage.

A well-qualified and trusted professional adviser can help steer this complex process, explaining the legal (and perhaps tax) implications of each decision regarding the business, and they may also help clarify your views on its future. An external specialist will work with existing advisors including lawyers, financial planners and accountants to develop a concrete and tailored transition plan.

If your family are unable or unwilling to take the business to the next stage, you will have to consider alternative options, such as a flotation or sale. Either way, it is beneficial to be aware of this possibility in advance, rather than face an emergency sale if you become incapable of running the business any longer. A sale of any kind can take at least six months and will almost certainly be stressful and time-consuming.

Tax implications

If this appears to be the best option, ensure that your expectations of the business’s value are realistic – it is only worth what someone else is willing to pay for it. A specialist adviser should provide details of similar transactions and advice on maximising the value in the business. This may involve management of key risks – including the fact that you may no longer be actively involved – or protecting intellectual property.

The tax implications of a transition will be important – inheritance tax considerations in particular should be front-of-mind for all involved. A popular rule of thumb is that 70% of wealthy families have lost their wealth by the second generation, and 90% by the third, according to US wealth consultancy Williams Group.

Many countries offer special exemptions for family businesses, but it’s important to take advice to ensure that the business is structured correctly to benefit.

Such conclusions are generally associated with succeeding generations lacking the drive and discipline of their entrepreneurial forbears, but inheritance tax certainly plays a role. Many countries offer special exemptions for family businesses, but it’s important to take advice to ensure that the business is structured correctly to benefit.

Divorce complications

Another issue to consider is divorce, whether your own, that of your children or a major stakeholder in the business, which can obstruct the most carefully considered succession plans. If a shareholder needs to cede part or all of their holding in a divorce settlement, it risks introducing into the ownership structure potentially unfriendly shareholders who may not have the long-term interests of the business at heart.

Perhaps the most important factor throughout the whole process is open dialogue, keeping key family members informed and consulted, so they can challenge your plans robustly, rather than fighting it out in the courts when you are gone.

Contemplating relinquishing control of a business that has been a life’s work is not easy, but early planning is vital for its preservation. Small steps – the appointment of advisers, asking children for their input, getting paperwork in order – can make the process less daunting.