Succession Planning for Business

For many business owners, succession planning used to mean selecting which child would follow them into the family business. When a will was made, that was the succession planning dealt with. If there was no family to succeed, then the fall back was a management buy-out and preparing the senior management team to take over the business.

While these may still be very important aspects of planning for succession, they only form part of good succession planning.  Proper planning needs a long-term approach and, indeed, starts as soon as the idea for the business is born. Choosing the correct entity structure, financing arrangements and incentive packages for key employees are all essential parts of creating a legacy that can be passed on to the next generation.

The vast majority of business owners do not have a plan for succession. Most will have a sense of who they want to succeed but failing to discuss this and make a formal plan all too often results in value lost, poorly planned sales and family disputes.

All of this can be avoided with a proper plan.

MKB Law has worked with the owners of large and small businesses, across many sectors and with complicated families to develop those plans.

The most common structures are:

  • Sole trader
  • Partnership
  • Limited Liability Partnership
  • Limited Company

Sole traders and partnership have unlimited liability so that all of the owners’ assets are available to the creditors if the business fails. Limited Liability Partnerships and limited companies limit their liability to the assets within the entity. These are obviously preferable from an asset protection perspective. Each of the entities is treated differently for tax and a proper assessment of the best tax structure needs to be made in every situation.

From a succession point of view, there are lot of benefits in a company because the division of capital into shares can be very flexible for transferring to children. This is particularly so if the shares qualify for business property relief for inheritance tax and capital gains tax purposes.

Yes. Where there are co-owners of a business it is essential to have a well thought out agreement which deals with:

  • Death
  • Serious illness
  • Retirement

Cross options are really useful tool when there are co-owners in a business. Properly drafted they allow the estate of a deceased owner to realise the value of the business without creating capital gains tax problems before death. They will usually be supported by business protection insurance and it is important that the policy is correctly written so that the right person receives the insurance money.

Often, in small businesses the co-owner is the obvious buyer. However, this is often just not practical:

  • Co-owners are often of similar ages and want to retire around the same time
  • Where the co-owners are all working in the business, the remaining owners may not want to pay a large sum of money to a leaving owner and then have to work harder to make up the shortfall in his effort.
  • It can mean having to keep substantial reserves to fund the exit which restricts the ability to grow the business.

This still remains the most common form of succession in Northern Ireland and can be successful where there is an obvious family member who understands the business and wants to succeed. However, only about 30% of family businesses survive the transition from one generation to the next. Issues that are all too common include:

  • Family not being properly trained. Often children do not have the hard-earned skills of their parents and entrepreneurial abilities that parents take for granted have not been learned by the children.
  • Forcing a square peg into a round hole. While parents may hope they are founding a dynasty, often it is just not right for the children.
  • Sibling rivalry can create damaging tensions within the business. This can be addressed by early planning and a recent device which has growing popularity is the use of a family constitution
  • Striking the balance between children who are active in the family business and those who are not.

In a MBO the key employees will buy the company from the shareholders. This can be a very effective form of succession planning if the right team acquires the business and it remains properly capitalised. In the most successful MBO’s the key employees are identified well in advance and a plan is put in place to give them the skills and understanding of the business that they will need to carry it forward.

Often, the main challenge for a MBO team is that they do not have the money to buy a successful business. This will mean that bank debt is required (leveraged buy-out) or very commonly, that the seller has to lend the MBO team the money to buy the business. This is done by the seller allowing the payments to be made over a period, which may be several years. Obviously, if the Seller is providing the money, then there is a risk that the Seller will be the main loser if the business subsequently fails. It is important that the MBO documents are prepared to give the seller the maximum protection against these risks.

We are seeing MBI’s becoming more common in the local market. Under an MBI a new management team buys into the business replacing the existing management team but leaving the owners with a, often significant, shareholding. This can work well where there has not been planning around succession and the existing team is tired so that it would not be capable of forming an MBO.

Typically, the MBI team will identify value in the business (so the immediate buy in may be at a discount to asset values) but the attraction is increasing the value of the remaining shareholding.

Congratulations. This is the goal of most entrepreneurs. From a succession point of view, you have converted a complicated asset into cash, and nothing is easier to deal with than cash. There is, however, one point that puts off some people interested in preserving wealth for the next generation. By and large, shares in a business are passed free of inheritance tax but cash is not. Therefore, by selling your business you have exposed the value of the business to inheritance tax of currently 40%. As Oliver Wendell Holmes said “I like to pay taxes. With them, I buy civilization”.

The retention of key employees is essential to any succession plan (and maintaining the value of the business). In addition to having clearly defined roles and compensation packages the ability to participate in the success of the business is an important part of the relationship with key employees. This is often done through share schemes, which may have tax advantages:

Tax Advantaged Schemes Non-Tax Advantaged Schemes
  • Enterprise Management Incentives
  • Company Share Option Plans
  • Share Incentive Plans
  • Save as You Earn/Sharesave schemes
  • Unapproved share option schemes
  • Growth/Hurdle Share arrangements
  • Phantom share Plans
  • Long Term Incentive Plans

These are complicated arrangements and specific advice needs to be sought from MKB Law’s employment or corporate teams if they are being considered.

We are seeing more private equity investors taking stakes in family businesses. Typically, this is an investment of growth capital in exchange for a share of the business.

This type of investor will want to see a return on investment within a fixed period which forces the owners to think about the exit. Will the investors be bought out or will the business be sold or listed? The discipline that private equity brings to the management and planning of a family-owned business can force succession issues to be properly addressed.

Family trusts can be a very effective form of planning, but they are also not appropriate in many situations. They can be very helpful where there are minor children, if there are family members who are not involved in the business or children who have a disability. Structures which allow capital growth in family trusts but the income on the capital be to be earned outside the trust are useful in some situations.

The taxation of trusts is a complicated area and tax advice should always be sought before considering any trust structure.

A family constitution is a document signed by the different generations of the family which sets out rights and responsibilities of the members involved in the family business and includes structures and principles for dealing with family wealth.

Gordon McElroy
028 9099 3111

Lynsey Henderson
Associate Director
028 9099 3117

Jose Lazaro
028 9099 3114

Shane Colton
Trainee Solicitor
028 9024 2450

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