Blogs

Importance of estate planning for family businesses


Did you know that a huge number of family-owned businesses do not survive into the second generation (
65 percent), and, on top of that, around 20 per cent fail once it reaches the third generation?

The reasons for this are many and varied. Some heirs are simply not the business leaders their parents were. Others don't have the same appetite for the sector. Others might have different risk tolerance. In still other cases, family rivalries and legal issues can tear a business apart from within.

It's for this reason that estate planning around the family business is so critically important. Without it, the family business will automatically move to the next in line, as the state determines, and that is done with little to no consideration for the health of the business.

In other words, having a structure succession plan allows you to control how the family business enters the next generation. Not only does that allow for the survival of the business, but it opens the door to expansion and allows for the preservation of the relationships among those stakeholders left.

With family-run businesses, the common business structure is either as a sole trader or a partnership. These allow for the easy running of the business but can have negative side effects, including:

  • Minimal benefits in terms of income and tax planning, as owners will be taxed at the marginal rate.
  • The unlimited liability of the owners (which could cause huge problems for the generation looking to take the business owner).
  • Difficulties in transferring businesses to successors, particularly if the business is a partnership.

It's for this reason that a lot of people when considering the business as part of the estate, move to a family discretionary trust. What this means is that a trustee can hold the assets (the business), on behalf of the beneficiaries (the successor/s). The benefits of doing this are wide-ranging, and include (but are not limited to):

  • Asset protection (now that the assets are not personally owned they're not easily available to a creditor if they come after the successor).
  • You'll gain additional discretion on how the business and its assets can be moved to the next family member – legal contracts and memorandums of wishes and reasons give you complete control.
  • You can distribute the business and assets while you're still alive, to ensure the smooth transition of ownership.
  • You separate the business from your will – so, the assets such as the business itself are no longer disposed of according to the outline of your will.

When business is done in partnership, one of the most effective options to ensure that the business continues to be left in safe hands after the death of one person is to allow for a smooth transition to complete ownership for the partner left, while ensuring that the family and estate of the deceased is not short-changed. This is done through what is called a buy/sell agreement, whereby the partner has the option of purchasing the assets to the business in the event of a death.

The benefit of doing this is that it protects the business, and particularly the partner. A buy/sell agreement takes precedence over a will, meaning that were the family to contest the deceased person's will, the business would not be subject to that unless the still-living partner opts not to buy the other half of the business.

It's quite common to take out life insurance policies to go with the buy/sell agreement, as an insurance policy then provides the money required to pay for the deceased partner's share of the business.

Regardless of the legal structures that you develop to handle the transfer of the business, it's also important that you consider closely just who you're going to pass the business on to. If you pass it to someone who isn't competent in the job, the business (and, possibly, them) will go bankrupt. If you pass it on to someone who hasn't got the time or inclination to take the business, your hard work might be sold or simply wound down.

Find the right person to succeed and take over the business. It may well be someone from outside of the family in the end but allow for the family to split shares to be majority shareholders, or retain roles on the board in order to keep the family business inside the family.

More than anything else, it should be clear that when it comes to family business and succession, ensuring a smooth transition is a complex legal process – much more so than handling a simple will. When setting up a will, you don't even need to have a lawyer witness it in order for it to be valid. With estate planning around businesses, however, it's important to have a solicitor look through all the assets and complexities to ensure that there are no surprises that disrupt a smooth transition when the time comes. 

30 under 30 honorees on the importance of reinvent...
15 Inspiring Entrepreneurs To Watch In 2020

Related Posts

 

Join Today!

  • #ShapingtheOdds is completely free to join and use, and community members buy into the pay-it-forward philosophy of openly sharing help, knowledge, ideas and advice to fellow community members. 

    Register below, or read more here!

  • We recommend that you register and log in using the Facebook button.