Business succession planning is critical in ensuring that any transition of the business, whether during your lifetime or following your death, is a smooth as possible. In recent years, family dynamics have changed, with more and more people now entering into their 2nd, or even 3rd, marriage or relationship, leading to competing interests between children of a former marriage and a new spouse. It is also increasingly common for some or all of the children to want to forge their own careers rather than take over the family business. Without careful planning, these more complex family dynamics can lead to significant disputes.
The strategies and tools that can be used in planning for a business succession will depend on the structure in which the business is being carried on. Most commonly, businesses will be carried on via a company or via a discretionary trust with a corporate trustee.
Relevant issues that need to be considered are:
- passing of decision making control and how to protect the outgoing parties against unintentionally losing control in respect of business decisions to the incoming parties during the period of transition;
- balancing the interests of each party to protect against two or more parties acting in a way that is disadvantageous to the other or others, while not enabling one or more of the parties to unduly frustrate decision making processes;
- protecting against the unintended passing of decision making control upon the unforeseen death or incapacity of existing directors or shareholders;
- if ownership of the business is to pass under a Will, protecting against an inheritance claim by a new spouse or other member of the family;
- adequately providing for the repayment (or other satisfaction) of amounts either owed to the business by - or owed by the business to - the outgoing parties without triggering unexpected tax liabilities;
- balancing any wishes of the outgoing parties to realise the value of their ownership interest in the business with little, or no, tax implications against any future tax implications for the incoming parties as a result of inheriting historical (lower) cost bases of assets; and
- ensuring income or profits from the business are distributed equitably amongst the parties.
While the strategy adopted in each case will be different depending on the family dynamics and the objectives of each of the parties involved, there are a number of tools that are commonly used in these situations to navigate through the issues. These include:
- granting powers of attorney to ensure that appropriate persons have the right to exercise rights attached to shares in a company (whether conducting the business in its own right or as trustee of a trust) during any period of incapacity and, if desired, at other times. Consideration should also be given to whether the powers conferred on the attorney should be restricted or limited in some ways, and also whether, where 2 or more persons are appointed as attorney, they must act jointly;
- ensuring the provisions of each person’s Will have been updated to properly reflect and accommodate that person’s wishes with respect to business assets or interests in entities that conduct the business. This includes not only ensuring that any specific bequests of property are set out in the Will, but also ensuring that appropriate persons are appointed as executor under the Will, given that this person or persons will have control over the estate assets during administration of the estate;
- using a Shareholders Agreement or Company Constitution to customise the rules relevant to the conduct of the particular company to suit the specific needs and objectives of the parties. These are useful both where the company carries on the business in its own right, and where it does so as trustee of a trust. Issues that are commonly addressed in these agreements include:
- the right to appoint and remove directors;
- specifying decisions that can be made by directors and those that must be made by shareholders and the percentage of votes that are required for the resolution to be passed in each case (e.g. 50%, 75% or 100%);
- whether any shareholder or director will have a casting vote or right of veto in respect of any decisions;
- rules around the issue of new shares and prohibitions against diluting the shareholding of any shareholders;
- exit strategies and rules and procedures that must be followed if any of the shareholders wish to dispose of all or part of their shareholding or in the event of certain events such as death, incapacity or retirement;
- policies as to declaration and payment of dividends;
- rules around borrowings to be undertaken by the company and/or contribution of capital by shareholders; and
- dispute resolution procedures.
- granting of call options to secure the right of another party to acquire ownership interests in an entity that conducts the business in the event of certain events such as incapacity or death of the existing owner; and
- where the business is carried on by a discretionary trust, inserting into the trust deed for the trust distributor provisions whereby the income and capital of the trust is notionally divided into portions, and a nominated person has the ability to direct the trustee as to how a particular portion is to be distributed.
While business succession planning can be a daunting task and present a number of unique challenges for most families, the consequences of not having a proper plan in place can be significant. It is strongly recommended that business owners put in place a properly considered succession plan, and review and update it regularly to take into account changing circumstances, to ensure a smooth transition of the business and to protect against unintended consequences in the event of unforeseen death or incapacity.