Business Succession Planning
Business continuity depends upon the next generation. But, succession planning can be complicated and sensitive.
How to pass shares to the next generation
Structuring share ownership
Where people are involved it is usually not enough to look purely at the legal aspects – good advice often requires account of the individuals involved and assessment of risk areas. Our years of experience will help you pin point the best planning for your circumstances.
Inheritance tax – business property relief
One of the more generous tax exemptions available at the moment is the 100% exemption to inheritance tax for shares that qualify for business property relief. In a nutshell, unquoted shares do qualify for business property relief. Another generous tax exemption is the ability to gift shares and avoid paying inheritance tax entirely if you survive the gift by seven years or more.
Review of the corporate structure
Usually plans for the future are cemented via rights given to shareholders under the articles and or shareholders’ agreement. There are plenty of possibilities all of which depend upon your objectives.
- Parents who want to pass ownership down to children but do not trust the strength of the marriages of their children – in such cases we design provisions for the articles or shareholders’ agreement which would make it difficult for an ex-spouse to claim entitlement to shares on say divorce.
- Partners who wish to retain wealth in the right hands. Changes in the law have meant it is now much more likely that a pre-nuptial agreement will be enforceable. We also advise partners who are being asked to sign pre-nuptial agreements.
- Fellow shareholders who are concerned that spouses may inherit under a will and inherit voting power – in such cases we can draft amendments to the articles or shareholders’ agreement which remove voting rights on death but pass rights to dividend and capital to the estate. The advantage here is for the spouse who inherits the shares and the capital value that goes with the shares and the existing shareholders who are free to continue running the business.
- Cross options for shareholders who want to acquire shares but are lacking in funds. We can draft cross option agreements into the articles or shareholders’ agreement which allow existing shareholders to acquire shares from a shareholder or a shareholder’s estate in stages as funds are available. Cross options can be supported by an insurance policy.
Freezer shares are popular and used to manage wealth generation in family businesses. The plan is new shares will be gifted to the next generation which operate as an inheritance tax mitigation strategy by keeping the future growth of the company outside of the estate of the older generation.
Freezer shares work in a variety of ways. They are designed to protect the older generation and motivate the younger generation. The basic idea is that current value attaches to the current shares and all of the future value held by the next generation attaches to new shares held by them. There will be tax implications on the receipt of new shares if the recipients are working in the business.
Example of the use of freezer shares
Using a freezer share the older generation could be given a right to sell their shares under a share buy back at a predetermined value and a preferential dividend to cover the equivalent of a pension and nursing home costs. The younger generation take what is left. There are variations on the theme.
Using equity incentives to pass ownership
In the right circumstances, equity awards can provide a succession plan for the next generation which are tax efficient. To be effective any award has to have meaning to the recipient and we look at that aspect as well as the legal points. A popular choice is the use of EMI options because they are so flexible and tax efficient. The basic idea is that the ownership is passed to the next generation when they exercise the EMI option and become shareholders.
Example of the use of EMI options
The exercise price under the EMI option represents what the younger generation will have to pay to acquire a stake in the business. The legislation allows total flexibility on what the exercise price is fixed at. This enables flexibility to decide how much, if anything, the business is passed down the line for.
The older generation want to pass say 30% of the company to the younger generation actively managing the business. If the business is valued at say £5 million for 100%, then 30% would be worth £1.6 million. The younger generation could be given EMI options over 30% with an exercise price of £1.6 million. If the business grows in value past the £5 million mark they could exercise the option.
Upon exercise the older generation would have disposed of the 30% they wanted to pass down. The advantage for the younger generation is that the growth is passed to them and they only pay tax when the shares acquired are disposed of.
The older generation would trigger a disposal for capital gains tax purposes when the the EMI option is exercised. Depending upon the facts, the rate of capital gains tax paid could be at the attractive 10% rate under the entrepreneurs’ relief regime.
There are practicalities to work through such as how the younger generation would fund the exercise price. If the business is not worth at least the exercise price the advantage to the younger generation is that they can let the EMI option lapse. EMI options are seen as a one way bet for employees.
Growth shares are useful for incentivising new managers. The idea is that the holder of growth shares can receive a dividend and or receive a share of the sale proceeds if the business is sold for more than a specified amount. How the entitlement is defined will depend upon how much the current owners want to give away.
Example of the use of growth shares
If the older generation felt the business was currently worth £10 million on a commercial valuation, growth shares could be created which create an entitlement to a share of proceeds on a sale worth more than say £20 million.
Shareholder fall outs
Fall outs in owner-managed and family-controlled companies are unfortunately common. We resolve difficulties with minimum hostility. Minority shareholders will have certain rights so care is needed in deciding how to respond to difficult situations. We have the necessary experience to do this, which we have gained through successfully resolving numerous disputes over the years.
Management buy outs
The next generation can be your exit strategy. We have worked with both sellers and the management teams. With an MBO there are always a variety of issues to plan for – the most important of which is usually funding for the MBO where we can deliver ideas for you.
Big decisions arise when it comes to succession planning in a private company. Our experience tells us that the best decisions are taken where you allow yourself the time to take advice on the options and then think them through carefully. There will always be risks associated with transfer of ownership. We will address the risks and look to see if we can iron them out.