Family Business Succession Planning – Some Legal Implications

If you’re building a business that you hope to one day past down to the next generation, planning will be essential. Here's why…

Family Business Succession Planning – Some Legal Implications

Approximately, one third of family businesses survive into the second generation with 10% to 15% that make it into the third generation. Figures released by the European Commission demonstrate that about one third of family businesses will be transferred to the next generation within the next 10 years. These figures illustrate that it is vital that family succession planning warrants further consideration.

A well drafted succession plan can provide detailed instructions of how the founder successfully managed the business. It provides a prosperous resource of information on key contacts, clients and suppliers and any nuances and idiosyncrasies.

Yet there are legal implications for the unwary founder even with a successful succession plan. With the recession having had such a harsh blow to commercial property values, presently there is an outstanding opening to diversify shareholdings to the next generation. Essentially, this can lead to a lower tax liability.

It should be equally appreciated that lifetime gifts made before taxpayers are elderly and made more than seven years prior to death, offer an opportune exempt transfer for inheritance tax purposes. In that event, capital gains tax is the only tax to be concerned about and transfers between husband and wife can considerably minimise that. Furthermore, for married couples or civil partners, even with the new transferable allowances under inheritance tax, up to £650,000 can now pass to the next generation without having to plan ahead.

Should capital gains tax be a cause for concern and inheritance tax is less of an issue, then consideration might be given to gifts hold-over relief. This allows the business owner to “hold-over,” that is, postpone all the gain. In such a case however, capital gains will only be paid on the “gain” if and when the next generation come to dispose of say the shares in the unlisted family business. When a disposal is made then the implications for capital gains tax arise.

Nevertheless, where the founder is minded instead to dispose of the business as a going concern then entrepreneur’s relief should be considered. George Osborne in his budget on 22 June 2010 increased the lifetime limit to £5 million per individual and all qualifying gains up to the maximum lifetime limit made are now simply taxable at 10 per cent. There are of course restrictions on qualifying for this relief and the founder should have at least 5% of the ordinary share capital with at least 5% of the voting rights.

Save for the above tax and relief considerations it is worth considering who should take the business beyond, how will the next generation be encouraged and motivated, and how will the outgoing founder continue to receive an ongoing income, if at all. For the founder, one way of making up any loss of dividend on shares in the family business would be to enter into a service agreement with the company with a salary proportionate to the founder’s ongoing and continued contribution. Another alternative is to create redeemable preference shares which give a fixed income in priority to any other dividends paid out by the company.

Whilst there is no assurance there will be a successful transition to the next generation, family succession planning for the future can bring its own rewards to the founder who built up a viable business and wishes to leave a legacy for the next generation.

Edward Daniel SolicitorsEdward Daniel, solicitor at Edward Daniel Solicitors in the City of London (EC3V). Edward is well known for advising high net worth individuals and entrepreneurs. 

This publication is a general summary of the law. It should not replace legal advice personalised to your particular circumstances and needs.

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