There’s a lot at stake in the transition of a successful firm from the first to the second generation and beyond, writes John Cradden.
If we’ve learned anything from the runaway hit US TV show Succession, it’s that managing a the handover of a family business to the next generation can be tricky, to say the least.
Given that some 75% of all businesses in Ireland are family owned and represent the backbone of the Irish economy by employing 68% of the workforce and generating over half of the State’s turnover, there’s a lot at stake in the transition of a successful firm from the first to the second generation and beyond.
“It should also be done as early as possible so as to generate the greatest number of options for a transition, and reduce the risk of succession issues distracting from the successful running of the business”
However, research indicates that only 30% of family businesses transfer successfully from one generation to the next. Most worryingly, a 2019 report by PwC shows only 18% of Irish family businesses in 2019 have a formal succession plan.
Succession planning needs to consider a wide range of issues, and not just things like tax planning or ownership transitions. It should also be done as early as possible so as to generate the greatest number of options for a transition, and reduce the risk of succession issues distracting from the successful running of the business.
So what should a good succession plan contain?
1. A clear distinction between the ownership and management transition
According to professional services firm Deloitte, the transition of both the ownership and management used to be executed simultaneously, but now they are often managed separately or at different stages.
In some cases, what often happens is that ownership may transition to family, but at a management level, best practice is to make sure the job of running the firm is given to individuals most capable of running the business – and that may often be a mix of family and non-family employees.
Even if non-family employees successfully assume senior management roles, the ownership transition remains a more difficult one. Should the company transfer to only those family members actively involved in the business or to all family members equally? If the latter option is chosen (perhaps because the majority of the owners wealth is tied up in the business), then expectations of both family members working in the business and ‘passive’ members need to be managed, says Deloitte. For instance, is generally believed that family members actively involved in the business should have an enhanced right to equity over those not part of the day-to-day management.
2. A will
Very often the application of the rules of intestacy – dying without a will – results in the deceased person’s property being distributed in a way that they would never have wanted. This is because the rules set out a list of people who are entitled to receive shares in the deceased’s property as well as the amount of these shares and the order in which they are entitled to receive them.
These rules may mean the business may end up in the hands of someone you might never have intended to involve in its future ownership or management.
When you make a will, you also get to choose who will administer your estate. A will allows you to name the person or persons who would be the most suitable and who will ensure your wishes are carried out.
3. A tax planning plan
A carefully drafted will can also help with inheritance tax planning by providing an opportunity to assess the overall position and consider what steps can be taken to minimise it.
Business owners will also need to think about the tax costs of the ownership transition for whoever is the chosen successor/s and how they might be paid for (and if they have the means). For instance, capital gains tax of up to 33% can arise unless there is an application for retirement relief, which can provide full CGT relief if the assets are transferred before the owner turns 66. Similarly, children receiving shares in a family controlled company can get a significantly reduced rate capital acquisitions tax (CAT) relief.
4. An Enduring Power of Attorney
An EPA enables you to choose someone to manage your affairs in the event that you become mentally incapable of doing so. It’s important in a personal context, but in a family business context, it helps to avoid such scenarios where children may need to go through a costly and lengthy ward-of-court process to obtain the legal authority to make vital decisions about the business.
5. A list all business assets
It’s always easier to divide up assets when you know exactly what you have.
6. A robust governance structure
Deloitte advises that a system of good family governance should be in place to help deal with what can often be complicated dynamics in a family business. This can detail how the board of management should interact with the family, and detail the internal controls and voting rights necessary to ensure that all decisions are made in the best interests of the organisation.
7. Clear communication
Whatever the plan is, it’s vital that everyone understands what the plan is for the ownership structure, and how the shares will be transferred. There should also be an atmosphere where any issues within families can be openly raised and discussed.
8. Engagement with professional advice
You’ll need to engage with accountants, tax consultants and solicitors as early as possible. The bank will also need to be approached for consent regarding the transfer of any mortgages on business properties.