Succession Planning for your family business

When a company is a family business, there is a lot to consider when thinking of succession planning. Not only do business owners need to think about what will happen from a day-to-day operations point of view, they also need to think carefully about future ownership and whether there is anyone within the family that will be able to take over the helm. Here we discuss some of the considerations and best options available when it comes to succession planning for your family business.

What is Succession Planning?

Family business succession planning is the process of transitioning the management and ownership of a family business for the future. This process can feel daunting and is one of the biggest decisions any business owner will have to make.

Family businesses are different from other business types as you do not have just business operations to think about. It is inevitable that family dynamics and sometimes dramas can come into play. Additionally, it can also be a struggle for the founding or senior members of the business to step down and let go of the day-to-day management. It is therefore crucial that the correct succession decision is made.

The Importance of Planning a succession strategy

As with any business, a well-organised, forward-thinking company will have an exit or succession strategy in place. This is the future of the company and therefore is vital to consider early on. It should be in the business plan as soon as possible as it is an integral part of the company’s long term planning and therefore needs to be thought out carefully. Also, ensure there is more than one plan. We all know life is unpredictable and whilst we like to be able to ensure our ideal plans come to fruition this may not always be possible. So companies will often need a Plan A and a Plan B.

Decide on Priorities

As an owner of a family business, you will need to decide what your priorities are, as this will be your guiding force when it comes to making final decisions about your exit or succession strategy. For example, if the key priority is to ensure your legacy continues with your name then family succession will be the best option. If your key aim is just to ensure your business continues to run in some form or another then you will have more options available when it comes to succession. If your only aim is for cash and the ability to retire, then a complete buy-out may be the best fit. Once you really think about what you want for both your personal future and the future of the business, your business plan will start to take shape.

Family Succession

Many family businesses choose to go with the family succession option if it is financially viable and they have the family members to make it work. Gifting down the shares of the business can be done in a tax-efficient way for many trading businesses. This option of family succession not only means that your legacy will continue, but it can also mean you will have influence in future business decisions and involvement if you so wish.

Whilst family succession is often a great option there are some potential pitfalls. For example, conflicts can often occur between key employees and any new family members. This is why the process needs to be thought out and done gradually to avoid as much upheaval.

Often a gift of shares will not be appropriate and the departing shareholder will need to be paid for their shares to provide funds for retirement. In these circumstances. There are different methods of achieving this:

Company Purchase of own shares

If some cash is required for sale, the company can purchase its own shares. However, tax legislation dictates the structure of the deal and this can cause a lack of flexibility.

Buyout

A management buy-out can be structured to involve family members as well. Family members may form a new company to act as purchasers and this can offer greater flexibility as consideration can be paid by cash, instalments or loan notes.

Trade Sale

If it is not the main priority to have a member of the family take over the business when succession planning, then a trade sale may be a great option for your business. This is when the sale is available to the open market and often includes a higher sale price than a management buy-out (MBO). It also usually means the buyer will have access to funds to finance the purchase.

Whilst this option is great when cash and the ability to retire are at the top of your requirements, there are some potential drawbacks to this option. There will likely be a high level of due diligence required from the buyer and this can be more unsettling for staff and client retention. The potential buyers could also be competitors, so sharing sensitive information could be a risky strategy at this stage.

Management Take Over (MBO)

A popular choice when succession planning is to allow management to take over / buy out the company. This allows the owner to train an internal team to take over the business. As we mentioned above, this management team may or may not include family members. This is a personal choice. An MBO allows the owner to retain some involvement or even shares in the company, but normally only a minority stake. There will be minimal buyer due diligence as the company is a “known quantity” and the timing of the takeover can be controlled by the owner, providing flexibility. This is also an excellent option for those who are concerned about securing their legacy. Having said this, there can sometimes be financing issues when it comes to financing an MBO.

Closing the Business Down

Closing a business down is never an easy decision to make yet sometimes it is the most viable option. This is often the case when there are no obvious buyers or successors. There are a lot of considerations when this is the path you want to take. From staff to tax, property, and much more. It can be an informal process where the funds are paid by dividend to shareholders which will be subject to income tax.

Alternatively, you may want to go down the Members Voluntary Liquidation route which is a process that allows shareholders to appoint a liquidator in order to formally close down a company that is currently solvent. This will lead to funds being paid to shareholders in the form of capital at Capital Gains Tax Rates.
Businesses must also be aware of the HMRC anti-avoidance rules (TAAR). This was introduced in the Finance Act 2016 that prevents owners from ‘phoenixing’ their companies in order to convert dividends into capital payments.

Tax Considerations

Whichever option you go down when succession planning, you will have to take the tax considerations. Most of the routes explained in this article will be taxable at Capital Gains Tax rate. This is 10% under the Business Asset Disposal Relief or 20% at the normal rate. As explained above, the informal winding down will likely to be taxed at Income tax rates on the dividends. Gifting of shares can be done tax-free for trading businesses. However, this becomes more challenging for investment companies.

Business Asset Disposal Relief (formerly Entrepreneurs Relief)

Business Asset Disposal Relief reduces the amount of Capital Gains Tax on a disposal of qualifying business assets after 6th April 2008, as long as you have met the qualifying conditions throughout a 2-year qualifying period either up to the date of disposal or the date the business ceased.
The rules are complex so professional advice is always needed to make sure that you qualify.

Succession planning is never an easy task for business owners, especially when they have built something from the ground up. Having a family business can also add another layer of complexity to the situation.