Family business & next generation succession
For any family business, handing over the reins to the next generation is a big decision. In this article, legal expert Paul Hardman explores the thinking behind next generation succession and the key considerations for any business owner.
I was impressed by a client who said to me recently that, having made a good income out of the business he took over from his father, his ambition was to hand his company over to the next generation. He then admitted that his thinking was a long way behind an Italian family-owned supplier that had been in the same family for 27 generations, which (as a mathematically minded friend pointed out) would mean that it was founded in the 14th century.
In the UK we are spoiled for choice. If you are an owner of a family business you put it on the market and sell to a third party trade buyer (and there is a healthy well looked after market in M&A in the UK for almost any size business), you could sell to the existing management team, you could sell to an employment trust in an employee owned model or you could do as my client suggested and hand it over to the next generation.
These thoughts made me ask some obvious questions such as why, how and when do you hand over the reins to the next generation.
Next generation succession – why?
The choice is personal, in part, like my client, a reflection on whether as the owner you see yourself as a custodian, whether a great offer comes along, the needs of the business, the make up and character of the people that influence you and that might be right to take on the role and the type of person you are, whether a strategic planner or a pragmatist who responds to opportunities as they come along.
In the UK, the family business model can be seen as a poor cousin to the more sophisticated, larger corporate and there can be an assumption that all family companies will be subsumed into the bigger corporate at some stage. That does not hold true in Europe, and it is time for a closer look at the reality of the situation in the UK (just Google ‘UK family businesses’).
Then there is the concern that the next generation (or their children or their children’s wives/husbands/partners) will squander the value or change the culture of the company – the three-generation rule comes to mind. Again, these are personal decisions but there is a lot that can be done to recognise that risk with the use of trust arrangements and special share rights – we have acted for clients recently where only blood relatives of the original founder were allowed to hold voting shares.
How do you pass a family business to the next generation?
Trust arrangements and share rights can be devised to address almost all eventualities that can be imagined (and many that can’t or aren’t). A good way to start is to split out the key elements of ownership:
- Control – in other words voting rights
- Income rights
- Capital value; and
- The right to be bought out.
These can be handed over separately at different times so as a business owner, you could decide that you would like your children to start acquiring capital value but to maintain control and income until later.
You also need to think about time, whether you want the arrangements to last for a number of generations (by using a trust) or just to your children (by using either or both of a trust and company share capital structures).
Getting the timing right for next generation succession
For tax planning reasons any gift would ideally be made at least 7 years before death (otherwise it will be subject to Inheritance Tax) and let’s assume it takes 2 to 3 years to plan and put these sorts of changes into place. The average life expectancy of males in the UK in 2020 was 86 (modal age at death) and of females was 89 (modal age at death). Therefore, tax planning should start before 76/77 (men) and 79/80 (women).
Let’s also consider the age of children. Under 18 years of age a person does not have legal capacity. The average age of mothers in 2020 for first children was 29 and second 31. There is no data on the age of fathers at first birth but in 2019 the average age of all fathers was 33. Taking these into account, if the situation is that the average age parent of two children is thinking about family succession, they have a window of 25 years (men) and 31 years (women) to put their plans in place.
Plenty of time you will say, but the reality is that most parents would not think of handing over the business to an 18-year-old. Say that average parent waited until their youngest child was 31, the window would be 12 years (men) and 18 years (women) and if they waited until the youngest was 41, the window is 2 years (men) and 8 years (women).
In other words, the reality is that for all but those of us that have a very long-term vision, it is a good idea to be planning long before you think you need to.