The succession of wealth is important and succession for family-owned businesses requires a careful transmission to ensure smooth continuity of business. A succession of a family business would involve the succession of its management and ownership, along with managing the expectations of the family members, which is very crucial element and cannot be ignored in the entire process of succession.
Management succession and ownership succession go hand in hand. However, once the second generation is actively managing the business and the founder can derive comfort, then the succession plan can be designed comprehensively through the participation of all the members of the second generation. Prior to this, it is important to have a plan for unforeseen contingencies such as sudden demise or incapacitation of the founder.
When the founder was managing the business, all the decisions were taken by him solely and the business was managed in an unstructured manner. But when the second generation has joined the business, the key concern would be to maintain harmony between the children for long-term business continuity and growth. Each child will have a different perspective on business management. Differences are welcome to bring different insights into business but the same should not hamper family relations. Therefore, rules shall be put in place for the decision-making process, defining the roles of each member, privileges & responsibilities, like in a professionally-run company.
All the active family members should through consensus lay down various rules for running of a family business, which can be documented in the form of a family constitution.
While planning for the ownership succession of the family business, the key objectives of the founder would be to:
- Consolidate the shares of the business
- Provide for retirement and incapacitation of self and spouse
- Create a multi-generation succession plan
- Long term business continuity and growth
- Delink ownership from management
- Asset protection from creditor claims
- Protection of business assets from disputes within the family members
- Avoid the court process of probate on demise for transmission
There are various tools available for passing on the shares of your company to the next generation, which can include a Will, Trust, Gift, Shareholder agreement or a combination of above. A private family trust is a very efficient tool for planning the succession of your business, which can meet all the above objectives as elucidated below:
Consolidate company shares – The business owner can transfer the shares of his business into a private trust. In this case, the shareholding will not be fragmented with different family members but will remain consolidated at the trust level. This will avoid any kind of transfer of the shares within or outside the family without the consensus of other family members and the voting rights will be exercised only by the active members.
Provide for own retirement and incapacitation – The founder and his spouse can be the beneficiaries of the trust, which would provide for their retirement. Even if the founder has transferred the shares into a trust for the benefit of his children who are now managing the business, the founder can remain a primary beneficiary of the trust and continue to derive benefits from it.
Multi-generation succession plan – The ownership of shares is now with the Trust, which will hold it for the benefit of beneficiaries who are family members. The beneficial interest of each family member can be described in the trust deed, the decision to allocate the beneficial interest between different family members could be given to the elder/active family members, or it could be a combination of both. The spouses of the family members may be included or excluded from the list of beneficiaries. One can also build in conditions stating that if the spouse of a family member divorces, he/she shall no longer be a beneficiary under the family trust. A private trust establishes a multi-generation succession plan where the beneficiaries can be defined in the second and third generation.
Delink ownership from management – Normally the shareholder (family member) also manages the business and should be entitled to remuneration for his managerial role in the business. Often the family members do not draw a remuneration according to the industry standards. This works well until the founder level but when multiple members from second or third generation are in business, their remuneration shall be fixed which should be at par with the industry standards because the second & third generation may have varying monetary expectations and spending habits. A trust would separate the ownership from the management. The active members are remunerated whereas both active and non-active members will receive benefits from the trust as prescribed under the trust deed in equal or unequal proportion.
Asset Protection – A business would need outside funding and bank loans to grow. The family members also give personal guarantees and their personal assets are liable to attachment in case of a default. However, one should avoid mixing personal assets with business assets. The same shall be segregated and if the trust is holding these assets, it would be protected from creditors’ claims.
As mentioned above, a family constitution is created by all the family members with their consensus where they agree and define certain rules for the family members with respect to the business.
While creating an ownership succession through a private trust it should have reference to the family constitution and the same needs to be integrated and drafted in harmony. For example, if a member wants to exit – the family constitution will define the decision making the process for one to exit which could include a demerger, buyback etc. The same should be reflected in the family trust.
A private family trust offers great flexibility and such references should be appropriately built-in keeping in mind the company laws and amending the Articles of Association where required.
When the shares are held by a Trust, the decision making is with the Trustees. The Trust may appoint other advisory boards which may comprise of other active members from a larger family who are not on the board of trustees – such as the spouses, members from third-generation when they join the business. The advisory can be recommendatory or binding. These provisions shall also be reflected in the family constitution.
If any of the beneficiaries under the trust is an NRI, then the cross-border succession laws must be adhered to while structuring and drafting the trust deed. While transferring the shares of a listed company into the trust, SEBI guidelines should be followed while structuring and drafting the trust deed. An application shall be made to SEBI in the prescribed form for moving listed company shares into the trust.
A well-formulated succession plan should cover the family objectives and also meet the necessary regulatory requirements. Planning for the succession of a family-owned business can happen successfully when one’s business is flourishing because it’s difficult to plan for succession in the middle of a crisis. Like rightly said, “A stitch in time saves nine.”
(By Namita Agarwal, AVP Succession Planning, Emkay Wealth Management)