Success = successful succession

At Mills & Reeve, we recognise that the components of succession planning cannot be looked at in isolation. A company simultaneously represents value for the family, employment for the officers and employees, and an investment for shareholders. These three elements, and the factors which drive each group of individuals, must all be considered to form an effective succession strategy. We take a holistic approach to advising owner-managed businesses and consider all aspects from both a business and estate planning point of view. This combined approach ensures that planning can be done which is in the best interests of both the business and the family.

The term “succession” often means different things to different business owners depending on where in the life cycle their business sits and the dynamics of their family. For example, it could mean looking internally and identifying someone to “step up” to the challenge of taking the business forward; or looking externally at recruiting the right people to take over. It might also mean a sale to a third party or looking towards the next generation as potential inheritors of the business.

While all of the above are clearly concerned with “succession”, there are many different approaches so it is important you have an adviser who can discuss the issues in a rounded way: whatever aspect of succession you have in mind, you will want to consider all the angles and make an informed decision about how to proceed.

Passing ownership – wanted dead or alive

A common problem for many business owners is identifying a suitable individual(s) to carry on the business while at the same time having a desire to treat the whole family fairly (and this does not always have to mean equally). Particular issues can arise in second marriage situations, where there are children from previous relationships.

Owners often face worries about the risk of passing on their business to family members, whether this be due to a risk of divorce in the family, or concerns about financial issues or simply whether the next generation is ready to shoulder the responsibility. This can lead to inaction, although in time the issue may be forced by either incapacity or death of the owner(s).

However, it is often possible to structure lifetime succession in a way that allows the founders to retain some control, while passing on the economic benefit of the business and other assets in an effective and tax efficient manner. We have experience of helping many families overcome these issues.

It is also important to cover the risk of an individual business owner losing mental capacity – this could happen suddenly, for example due to an accident, so it is important to be prepared. Lasting Powers of Attorney (LPAs) can help in this context: they allow you to appoint someone as an “attorney” to manage your affairs. This would include running a sole trader business and exercising voting rights on company shares. However, care must be taken over who would exercise a company director’s powers and undertake their responsibilities because an attorney under an LPA cannot exercise directors’ powers. It is therefore vital that appropriate provisions are built into the company’s articles of association to ensure that, if a director does lose capacity, this does not affect the running of the company.

Particular problems arise when a sole shareholder, who is also the sole director of the company, dies without arrangements having been put in place. Modern articles frequently address this problem by allowing the deceased shareholder’s executors to appoint a replacement director but this is not always the case, especially if the company does not have up to date articles of association. In the worst case scenario, it might even be necessary to seek a court order to rectify the situation and install a new board. This would be expensive and time consuming: any such delays could affect the company’s commercial position, so it is certainly worth thinking ahead and making sure the necessary powers are included in the articles.

If you are the sole shareholder and/or sole director, you should think about whether it is sensible to introduce other people, although it is also important to consider very carefully the balance of power and to be comfortable that the business will be in “safe hands”, including after your death or loss of capacity.

Before introducing other shareholders, review the articles of association of the company and make sure there are provisions which address what happens if those shareholders leave, die or wish to sell their interest. We can advise you on an appropriate constitution which enables succession planning but also protects the business from the risk of ownership becoming too dispersed or held by people who are no longer active in the business or are not family members.

Whatever succession arrangements you decide upon, if your business is structured as a company, it is important to make sure the articles of association (or other constitutional documents) support your requirements. Similarly, partners should review any partnership documents and agreements.

Searching for a successor

Sometimes there is no obvious family member to step up and take the business forward so founders look to bring in someone external. In these scenarios, family trusts can allow the value of the business to be retained for the benefit of the family, while at the same time ensuring the future leadership of the company is protected. It is possible to introduce different classes of shares to reward and incentivise employees differently from the family. Tax advice always plays a key part in shaping these arrangements as well as commercial and corporate issues, so early advice is vital.

Again, it is important to cater for the situation when a shareholder who is introduced to the business decides they wish to leave, falls ill or dies. It is useful to be able to control who can receive shares in these situations, and for this reason it is common to state in the articles that shares must remain in the hands of family members and/or active participants in the business.

Sale to a third party and alternatives

If considering a sale to a third party it is vital that, so far as possible, advice is taken well ahead (ideally at least 24 months ahead) of any proposed sale. This allows the necessary time to make any alterations to the ownership structure to allow tax reliefs (such as entrepreneurs’ relief from capital gains tax) to be maximised, ensuring the sale is as tax efficient as possible for the family. Again, it may be possible to structure this in a way that allows founders to control the family wealth.

Typically, a buyer will want to acquire 100 per cent of the shares in the company. Therefore, it is helpful to include provisions in the articles of association which enable a selling majority to “drag along” any minority shareholders to the same exit at the same price. It is key to get these provisions right, otherwise a sale could be derailed by reluctant, absent or estranged shareholders who might
only hold relatively small stakes.

An alternative to an outright sale may be to extract some value by introducing a third party investor, on appropriate terms.

Other considerations

An important part of succession planning is thinking about the commercial and other non-legal implications of a death, generational change or any other change in ownership of the family business. Employees might get unsettled, customers could become nervous, and competitors may sense a moment of weakness. Internal and external communications must be right and any transition needs to be planned and carefully managed.

Conclusion

Taking an holistic approach to succession planning means recognising that the whole is greater than the sum of its parts. Business owners should review all of the succession options before making important decisions and then make sure their succession plans are supported by the way the business is constituted and organised.