Paul Hardman, Director of Corporate & Commercial at GL Law answers the questions he is most often asked by business owners thinking about business succession planning.
- When should I start planning and where do I start?
If you’re like me, working from home has given me the chance to reflect away from the office about the business. For many business owners I think the pandemic has provided a chance to get away from the grindstone and reflect on longer-term legacy. One of my clients got in touch last year after reflecting on his own mortality and how his family would get on if he wasn’t there to run the business. He asked an old friend to take over the chairman role, with support from me as his company lawyer. We put in place various measures to help him do that in an efficient way – more about that later.
In this client’s case, we started by looking at the business and assets. There are many good tax reasons to split trading assets and investment assets. But those tax differences also underline the qualitative difference between trading and investment assets. As a broad generalisation you can think about trade involving that high degree of risk and backing yourself to succeed, whereas investment is more about taking a measured risk often with several beneficiaries.
For family-owned companies, how you arrange those assets can help address different family members personal strengths while maintaining a broad fairness that family members will want to keep. For example, in a demerger where the business has a substantial asset, in the case a freehold property warehouse. We would take that out of the group and put it into a separate entity before we could then address the family requirements for the remaining rather smaller business that was left. Once we had done that, we were then able to make progress.
- How do I deal with different types of shares and shareholders?
A company can have a share capital that consists of more than one class of shares. This can be a useful tool within a company to allow a number of groups of shareholders to have different rights attaching to their shares.
The most usual way in which classes of shares can be distinguished is between voting and non-voting shares. That can be used where there is a requirement to allow one group of shareholders to benefit from dividend income on their shares but where it’s not appropriate for those shareholders to take part in the decision-making process at shareholding meetings. They will very often be used in family companies for proper tax planning purposes to allow dividing income to be paid to family members who may not have other income and can therefore take advantage of tax personal allowances to extract money from the family company. Also, with different classes of shares its possible to declare different levels of dividends across the different classes, perhaps you recognise different levels of contribution to the running of the business.
Another refinement is that you can have preference shares, so the holders of that class of share are entitled to dividends before the other classes of shares and you can even provide for a fixed level of dividends (subject always to availability of appropriate distributable profits).
Using different classes of shares can allow for some creativity within what can sometimes be seen as a rather rigid company structure. I have recently dealt with a family company where it was very important to the family to keep control and direction of the company within the immediate family. So, in that case we’ve created a share structure under which only direct bloodline descendants of the founder of the company who actively worked in the business of the company were allowed to hold voting shares.
Where a company has different classes of shares, you need to give thought to several issues. What happens if a shareholder of one class of shares wishes to dispose of their shares, whether by a gift or selling them to third party? You might have provisions in place requiring a shareholder to dispose of their shares in certain circumstances, for example they cease to be involved in the business on a day-to-day basis, and what happens if a shareholder dies? In any of those circumstances do those shareholders or their personal representatives have to dispose of their shares, or can they keep them? If they’re obliged to dispose of them it needs to be decided whether its preferable that shares of one class can only be transferred to holders of the same class of shares.
In some situations, there may be no one willing to take on or buy shares under the rules you’ve agreed. Would it be acceptable at that point for the shares to be offered to shareholders outside the relevant class of shares or to a new shareholder altogether outside the company? The final default position is that it may always be possible for a company to buy back the shares itself, in which case those shares would be cancelled.
- How important is it to have a shareholder’s agreement in place?
A shareholder’s agreement is valuable, not just as a legal document but for the process you need to go through to produce the agreement. Various issues will need to be discussed, debated and resolved, and everyone then knows where they stand when it comes to those important issues affecting the life of the company.
It covers the management of the company, voting levels for key decisions, the dividend policy of the company, and the relationships between the shareholders – particularly what will happen if one of the shareholders decides they want to sell. When the shareholder is compelled by the agreement to sell, what happens if only some of the shareholders want to sell to a third-party buyer?
Typically, shareholders will have rights of pre-emption, as previously mentioned, where shares of an outgoing shareholder being offered around to the continuing shareholders and the continuing shareholders or the company itself having the right but not the obligation to buyout the outgoing shareholder. Then the question arises at what value, and here the shareholder agreement is very useful at defining how the shareholders regard the investment in the company. Whether it is to be on the basis of a proportionate value of the whole company or on the basis that the value of the shares as a separate tradable asset. If it is a separate tradable asset the value of the shares will be at a discount if those shares represent a minority or at a premium if the represent a majority of the shares. For relatively small shares, say 10% the discount can be in the region of 80-90%, so getting this right would be hugely significant.
Another significant issue to address is whether the shareholder is linked to a continuing role in running the company or more generally in the success of the company. If there is that link, then the shareholder who leaves the company can be expected to require to sell their shares to the other shareholders when that happens.
- I have a shareholder’s agreement, do I need to review it?
If you’re thinking about business succession, it’s a good time to have a look at your existing shareholders agreement and make sure it covers the points above and if you have cross option agreements (linked insurance policies). The insurance policies will pay out in the event of an insured event occurring such as incapacity or death, so the idea is that a cross option will allow those shares to be bought out and the insurance will provide the means to do that. Now is a good time to review the value of your company in today’s market and it may produce a reassessment of the premium that’s payable on those insurance policies and an amendment of the buyout price.
- What happens if a director or shareholder becomes incapacitated or dies?
This topic is always difficult to think about, particularly for new companies, but the Covid crisis has shown us that the unexpected does happen. If advanced thought and planning hasn’t been put in place through appropriate procedures, in worse case scenarios it could mean that the court has to be involved to resolve matters.
The good news is, however, particularly now businesses owners have more time to sit back and think about the underlying structures of the business, there are things that can be done to provide a sound basis for a business in the unfortunate event of death or incapacity. If you take the least complicated issue first, such as what happens if a shareholder dies or becomes incapacitated, a person’s shareholding is a personal asset which will (unless something else has been agreed) pass with their estate under their will, or if a will isn’t in place under their intestacy rules. This can be particularly difficult in the company where the shareholders and the directors are the same people as this can mean that the surviving directing shareholder is left to run the business without the assistance of their colleague, while the beneficiaries of that departed colleague who inherit their shares take the benefits in the form of dividends or any capital growth, which is solely attributable to the hard work of the surviving director shareholder.
I have acted for clients in the past where that’s been something they wanted to happen should either of them die, but it does need to be thought through so that it’s a positive decision rather than a default solution. If you are thinking about what would happen to your own family it’s important to remember that there is never any guarantee of a dividend being paid to a shareholder, so there’s no guarantee of any ongoing income to the shareholders. In that case would it be better for the survivor to have the right to buy the shares of the deceased shareholder? That would also mean that the family of the deceased would be able to realise the value of the shareholding that’s freeing up cash for living expenses etc. That of course raises the issue of how that purchase could be funded by the survivor and this can be covered by a way of insurance policies.
So, considerations really apply in looking at the incapacity of shareholders, does the incapacity trigger an offer around of shares to the shareholders who are still active in the company.
- How can business continue in the absence of an incapacitated director?
It’s not possible for a director to delegate their decision-making authority under company law. However, it is possible to appoint an alternative director, someone who would step into their place for as long as the incapacity continues. Those arrangements must be put into place on a contingent basis to become effective in the unfortunate event of an incapacity. It’s easy enough to decide to think about such things later or when you have more time, but speaking from experience, even before COVID, it’s always worth having these discussions and putting procedures in place to protect your own position and that of the company. I once acted for a company with young and energetic shareholders and one shareholder went on a water sports holiday and suffered a catastrophic injury and was left seriously incapacitated and unable to work. Fortunately, they had seen me a while before and we had put a shareholders agreement in place and we were able to use the provisions in that shareholders agreement to enable the remaining director shareholder to buy his colleagues shares and enable the company to move forward whilst also providing the funds for the ongoing living expenses and care of the incapacitated director shareholder.
- When should I start thinking about succession planning and what are the key issues to consider?
If we think about your successor that might mean your buyer of the business and if you’re thinking in those terms, I will always recommend you start to think about selling two or three years before you are ready to put the business on the market. It will take that time to get your business ready and fighting fit for the best price. If you have family members in mind to take over the business, it’s a personal matter for you as the owner of the business and for your family members as the potential successors considering their age, experience, position in the company and your own attitudes towards their involvement in the company, its success and your future in it. However, I would say that it’s never too early to start planning and there are many intermediate steps that can be taken to start the process and to start involving family members in a contained way if that is what you want until the time comes for them to take a fuller role.
As for the key issues, it is difficult as everyone is different, and everyone is motivated by different things. I would find out what success looks like to you and write this down in your Business Life Plan as a good starting point. With family businesses it involves asking yourself whether it is the money that business produces that defines your success or the difference the business makes to its community or the involvement to the team around you that really matters. These are personal issues, and I would suggest thinking these through carefully. It doesn’t just help you define your own goals. It will also help those around you e.g., family members, management team members and fellow shareholders to create a better understanding. Finally, it is important that once that process is complete your wishes are known and recorded.
- How do I bring all the detail together, and do I need to involve a solicitor?
It’s not always easy to think ahead and plan an exit from your business, whether it’s looking at plans to move towards retirement or sale, or if you’re concerned about the impact of death or incapacity. It is however a positive step in ensuring a solid basis for your company in the event of a sale or an unexpected event. By putting plans in place now, you can protect the future interests of the company, its shareholders and employees.
I would recommend seeking professional advice from your solicitor, accountant and financial advisor as early as possible to put structure around what your intentions and wishes are.
As solicitors we will be able to encapsulate your wishes and make sure the legal documents are in place to reflect what’s intended. We can also help you work through a Business Life Plan that takes a holistic look at the other factors involved in successful business succession.
To contact Paul Hardman, please call 0117 906 9400 or email email@example.com
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