Succession planning secrets for family businesses
Family-owned firms are a key part of business in the UK, so why do some not survive for the grandchildren? Nick Huber explains how good and timely planning is key to keeping it in the family.
High street companies and giant tech firms may dominate the headlines, but family businesses are the core of the UK economy.
Two-thirds of UK businesses are family-owned, generating over a quarter of the value of goods and services produced by the UK economy and employing around 9.5m people, according to the Institute for Family Business.
Yet look closer and all’s not well in family businesses. Only about 20 per cent of family-owned businesses in the UK make it to the third generation, according to Imperial College Business School. Or as the Chinese saying goes: “Fu bu guo san dai,” which roughly translates as: “Wealth does not pass three generations.”
Handing over power to the next generation is tricky in any business, but particularly in family businesses, when biological bonds can interfere with boardroom decisions and nepotism with meritocracy.
Only one in two (49 per cent) UK small businesses have a succession plan, according to research by Barclays Bank, published in 2015.
“When a business is in trouble having a solid plan can help to steer it back to good health,” says Rebecca McNeil, managing director for business lending and enterprise at Barclays. “A lack of succession plan can put the future success of a business at risk, so this needs to be considered far earlier and more formally than the results show.”
Carole Tomlinson is a partner with law firm Anderson Strathern. She says: “Succession planning is different in family businesses. It is not just a recruitment drive to bring in the next CEO. it is a much more personal process, in which family issues and anxieties will also need to be addressed.”
Succession planning is a process, Carole argues. She explains: “The value is in the actual process rather than the legal implementation that occurs at the end of it. If managed effectively, that process opens up the channels of communication between the generations, allowing expectations to be managed, and family values and business values to be explored, agreed and passed on down the line.
“Most importantly, if done well, it is about getting everybody heading in the same direction, adding weight to the succession plan and giving it a higher chance of success.”
Five succession planning tips
This is about building and passing down a stronger business to future generations. Stewardship can also include concepts such as trustworthiness, honesty, a sense of responsibility and community. Consider writing a “stewardship declaration” as part of your family business constitution or mission statement. It may include rules about managing family and business assets, dividend distributions, personal financial planning and succession planning and family members’ obligations to a business.
2. Build a professional board
Find the right people. Run a “gap analysis” (“Where are we and what are our needs?”). As well as knowledge of the business and its industry, directors should bring experience, independent thinking, inquisitiveness and sound judgement. Candidates should understand the family business culture, the Institute for Family Business says.
3. Succession plan
A succession is about a transition to a different business structure with a distinctive culture, new procedures and changing rules. It’s a good idea to have a written succession plan, which should include a strategy to develop leadership and skills, choose a successor and their starting date. It should also include an exit plan for the departing owner, career paths for key managers and family participation under the new leader.
4. Inspiring the next generation
Education, training and hands-on involvement in the business can help spark an interest in the family firm.
Work experience at the family business during school holidays may also help. So can encouraging family members to do an MBA and other graduate-level qualifications and encouraging a sense of connection to the business via family projects, like writing or updating the family history.
5. Branding the family business
Agree on the aims and objectives of the business, including family values that are “embedded in the business”. Agree how each family member will represent and communicate the brand.
Family dynamics can complicate succession planning. “[Family businesses] are probably 10 times more complicated than a non-family business because of the emotion,” says Martin Stepek, director of culture and communications at law firm Wright, Johnston & Mackenzie (WJM) and an expert on family business.
“Parents have to think through what’s right for the family and the business and they don’t necessarily equalise,” he says. “It requires an awful lot of thinking and discussion.”
Things can get fraught if some siblings are involved in running the family business and others aren’t, but still expect a stake in it.
“You don’t really want to give family members equity if they have never been involved in the business,” says Tom Hughes, director at Gerber Landa & Gee, a chartered accounting firm in Glasgow. An alternative to equity would be to give family not involved in the business a one-off cash payment, he says.
Another common mistake is not leaving enough time for succession planning. A plan for a large and complicated family business, including tax, governance, law, management and brand/marketing can take a couple of years. Smaller businesses might take a few months.
Succession planning is different in family businesses. It is not just a recruitment drive to bring in the next CEO. it is a much more personal process, in which family issues and anxieties will also need to be addressed.
Early and open discussion about the future ownership of the business (perhaps five or even 10 years before the owner or owners hand over the business to a younger generation) reduces the risk of confusion over changes to the business structure and strategy.
It’s a good idea to allow time for correcting mistakes when making a succession plan.
Martin recalls one very wealthy Scottish-Italian family firm that was almost ready to pass the business on to the younger generation. But then it realised that its succession plan did not include the single biggest asset: property in Tuscany worth many millions. The succession was delayed and the plan revised, and it was important to clarify which part of the property belonged to the family, and which to the business.
Wates is an example of a well-planned succession. Between 2006 and 2008, the family passed its Surrey-based construction services company from the third to the fourth generation based on planning that had begun back in the late 1990s.
“My advice would be to make succession planning a continuous process,” retired group chairman Andrew Wates says in a report published by the Institute for Family Business. “Indeed, we’ve already opened a dialogue with youngsters in the fifth generation.”
The three features of a successful transition are “transparency, dialogue and fair process,” Andrew says.
There’s a compulsory retirement age at Wates but the business succession was based on the senior generation progressively “stepping back” rather than “stepping down”. Andrew gave up his responsibilities as family chairman and switched to a leadership role at the company’s charitable foundation.
Passing it on
Any succession plan will need to consider tax, of course. The good news for families is that the UK tax system for transferring business assets or ownership of a business is fairly generous.
It’s possible for a business owner to pass on their business free of tax when they’re alive or after their death. But only if all tax reliefs are claimed.
The most important tax breaks are business relief, which exempts business assets on 50 per cent or 100 per cent of inheritance tax, and holdover gift relief which can exempt business assets (including certain shares) from capital gains tax when they’re given away.
One of the big issues for family businesses is checking that [the tax reliefs for the transfer of business assets] are available.
“One of the big issues for family businesses is checking that [the tax reliefs for the transfer of business assets] are available,” says Susan Hoyle, a partner at WJM who advises family businesses on succession planning.
The rules are not always obvious. For example, businesses that derive a large proportion of their income from property rental, separate to the main business and classed as an investment, may not qualify for the inheritance tax relief normally applicable when business assets are passed on.
“If you don’t get all the inheritance tax relief, you have to be clear where to get the money from to pay the tax bill,” Susan says.
After you’ve protected the wealth of your family business, what are the best procedures for transferring it to family members?
One way, according to law firm Davidson Chalmers is through a share buyback scheme. In this arrangement children in the family are given a small initial stake by their parents, followed by a staged repurchase of the parents’ shares by their company.
“The buyback allows funds to go to the parents and although the parents will have made a disposal for tax purposes this can very often receive favourable tax treatment if the parents are able to satisfy the conditions necessary for entrepreneurs’ relief,” partner Stuart Duncan wrote in a blog.
The buyback can meet the different family generations and can ensure a smooth transition of power in the business, Duncan says.
It reduces the parent’s holdings for between five and 10 years while also increasing the percentage of the children’s shareholding by a proportionate amount.
Another tax-efficient option, according to Duncan, is the demerger of a division within a family business which is either sold or gifted to a family member.
Family businesses are one of the most enduring parts of capitalism. But many don’t survive beyond a few generations.
Careful succession planning, started years or even decades in advance, combined with a review of branding, governance and training, can help family firms survive and thrive beyond the tricky third-generation transition.
The full version of this article appears in the June 2016 edition of CA magazine.
Nick Huber is a freelance business journalist.