19 January 2022
Don’t start with the tax - successful family succession planning
The pandemic has caused many of us to re-evaluate our lives, and this has been particularly true in the family business sector. Some businesses have thrived in the chaos, others have been hit hard and had to change their best made plans. Either way it has caused business owners to review their operations and has brought family governance and succession planning to the fore.
The focus here is on family businesses, but much of what is written is equally true for families with significant wealth. The question in either case is where do we start when we, their advisors, are tasked with guiding them through the uncertainties of family governance and succession planning.
Despite the importance of tax in the overall thinking, we are at pains to say to clients that the “tax tail should not wag the dog” and urge clients not to make this their starting point. Rather, the first question should be – what do you want to achieve? The answer to this is rarely straight forward and will depend on myriad factors including the stage of the family’s business, the ages of the dramatis personae and the relationships within the family. It is only by exploring these factors that a start can be made to the succession planning process.
Often a client (be it a patriarch or matriarch) has not actually considered what they wish to achieve. They may for example have been so fixated on the progress of their business that they have not stopped to consider the implications of material changes in either the business or family circumstances. The client may also have concerns about planning for the future, stemming from the perceived de-motivation of the next generation or their reservations about that generation’s capabilities more generally. Ironically the greater the truth in their concerns the more important it is to address these at an early stage.
As part of establishing a client’s motivations, it is important to differentiate between two aspects of the business: the control element and the economic element.
Looking at control of the business, it is not unusual for a client to suggest that they are more than happy to relinquish (some) control in favour of the next generation, but only once they consider the next generation to be ready to take on the batten. This seems logical, until one realises that in their eyes, the next generation will never be ready (they will, after all, always be their children). The key at this point is to consider how the next generation(s) can be involved without usurping the patriarch/matriarch. This is delicate and is where structures come in useful, and the two main contenders are trusts and companies.
The advantage of trust structure is that the control and economics can be kept apart and this can often protect the underlying assets (most notably the family’s interests in their business). The disadvantage is that not every client is comfortable with the idea of passing assets into a structure with so much flexibility and so little certainty. If this is the case, the next consideration is whether the existing company (or a form of holding company) could be used to try and break up the control and the beneficial interest. Sometimes the use of family investment companies and alphabet shares are useful at this stage. The advantage of this route is that it works both in a common-law and civil law jurisdiction. Further, whether helpfully or not, it crystallises the position and leaves limited discretion. In either case tax will be a consideration and may limit the client’s options, but until the client knows what is on the table, he/she will not be best placed to dismiss them.
Regardless of which route is adopted, once a child can demonstrate that they are capable both financially and in terms of running a business, this is when the older generation may be willing to concede a level of control. There is obviously a Catch 22 here, in that the older generation will not be prepared to do so until they are comfortable that the next generation are capable, but the next generation will not have the opportunity to demonstrate their capabilities until they have been given the responsibility. It is often this dynamic that needs to be played out. The parents will see it as daunting for the next generation, and the next generation will not know what is involved because they have never had the opportunity. At some stage there has to be dialogue between the generations and an element of trust from all parties. Involving the next generation in discussions early in the process can really help in this regard. It is an opportunity for the client to set out his/her concerns, and for the next generation to develop a greater understanding of what is actually involved in running the business.
It is not unusual for the next generation to feel the responsibility of wealth and the pressures that come with it very strongly, and for this to manifest itself in an apparent apathy or unwillingness to immerse themselves. The sums involved can be daunting and the success of the previous generation can demotivate. It is easy to assume that a wealthy next generation is demotivated through sheer excess or entitlement, but there is another side to the coin and that is that they feel like they will never quite be good enough. This can be rectified if they are brought into the fold and made to feel like they can achieve something within the business or with the wealth that has been provided for them. It is easy to assume that this should be done by way of sheltering the wealth so that they do not have access to it. However, in some cases this can in fact be demotivating in itself. It unquestionably sends the message that their parents/grandparents do not trust them and do not think that they are capable of maturely dealing with the wealth. However, it fails to see that in fact an education by the older generation can be beneficial and help with this. Often this is why it is beneficial to have a third party involved who can see things objectively without the parental prejudice that can be so evident.
It may be clichéd to say that it is a journey, but this does capture the essence of what we are dealing with. It is generally not a journey with an end, but it does twist and turn and produce some unexpected adventures along the way. As an advisor it is a privilege to be a part of this and to watch the successful succession of family businesses and we are delighted to support our clients and the next generations as they go.
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This publication is not intended to provide a comprehensive statement of the law and does not constitute legal advice and should not be considered as such. It is intended to highlight some issues current at the date of its preparation. Specific advice should always be taken in order to take account of individual circumstances and no person reading this article is regarded as a client of this firm in respect of any of its contents.
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