Keeping it in the family

  • Author : Julian Washington
  • Date : April 2013
Julian Washington TEP is Private Client Director at RBC Wealth Management

As entrepreneurial wealth increases, more business families are faced with the important task of effective succession planning to pass this wealth to the next generation. It is a process that can be time-consuming and emotionally challenging, and it is one that has been getting more complex as the nature of businesses and the social patterns of family life shift.

Succession planning can be an intricate affair for any family that wants to transfer its wealth smoothly from one generation to another. With family businesses, however, there is an added element of complexity: dealing with an asset that could take various forms and be fraught with emotional sensitivities, as well as the particular commercial pressures of the business in question.

Wealth through the prism of culture and mobility, a 2012 report by RBC Wealth Management into internationally mobile wealthy individuals, conducted in partnership with the Economist Intelligence Unit, found that 17 per cent of the high-net-worth individuals surveyed had accumulated their wealth through entrepreneurial endeavour – against only 4 per cent who had inherited their wealth.

For these families, there will be a clear need for good succession planning advice as, in most cases, they are also the first generation to enjoy wealth on a large scale – 70 per cent of respondents came from families that would not have been considered high-net-worth.

Considering the variables

With an active family business, several factors need to be considered. The first to be addressed is the immediate business plan if the current principal becomes incapacitated or dies. Where the children or heirs are not involved in the running of the business at all, a decision to sell will be the most straightforward outcome, as it provides a single pool of liquidity that can easily be divided between them.

A more complicated scenario is when the principal specifies that (in the event of their incapacity, illness or death) the business should be kept running for the long-term benefit of future generations. Difficult commercial decisions will need to be taken as to how to operate the business and who will be involved in that process. In some cases, a question may ultimately arise: is it possible to honour the principal’s wishes, or is a sale inevitable?

Third is where a group of beneficiaries have, between them, inherited the business, and each has a different approach and view on what the outcome should be. For example, one child who has long been involved in running the business may wish to continue with this role, whereas another may have no interest in continuing and prefer to take the inheritance as cash.

Compounding these issues is the fact that the shape of families today is highly varied and can be complex: the pace of change of the law rarely keeps up with shifting social patterns. So it is that business families can face serious challenges in their succession planning due to the complexity of their heirs’ lives. For example, how should we deal with heirs who are in so-called common-law relationships, but not formally married? What about civil partnerships, and the issue of how they are recognised (or not) in different jurisdictions? Where there are stepchildren, are they to be included as beneficiaries, and to what degree compared to their siblings?

Families that do not take good advice can face serious tax, legal and succession consequences. By contrast, well-advised families, using structures such as trusts in appropriate cases, can take all these variables in their stride.

Guiding the process

For some families, succession planning sometimes seems almost too difficult to talk about. For both the older generation and heirs, discussing parental mortality or incapacity can be distressing. In some jurisdictions, it is also considered to be culturally inappropriate – in China, for example, death is a taboo subject. Some business owners also fear that even raising these issues may lead to acrimony among the future beneficiaries, and they may agonise about the difficult decision of which of their children should succeed them. Advisors have to bear all these factors in mind when guiding their clients through this process.

Of course, the review of a client’s needs and circumstances has to encompass not only aspirations for the children’s inheritance and the direction of the business, but also their tax position, legal and other implications of where beneficiaries are located and their personal and marital status. In the right cases, discretionary trusts can offer the high degree of flexibility necessary when confronted with widely differing circumstances among beneficiaries. In the usual way, the trustee will have broad powers to enable it to respond, in light of changing circumstances, to the settlor’s wishes. This flexibility is valuable for estate-planning purposes because none of us, even those with neat, nuclear families, can be sure what the future holds.

“Establishing a clear plan for how assets should be handled is essential to securing a healthy future for the business”
Careful planning

For the purposes of such a trust, care is needed when it comes to naming the beneficiaries. In the case of fixed-interest trusts (such as life-interest settlements), one would expect the trust deed to identify the beneficiaries specifically and precisely. By contrast, in the case of discretionary trusts, one option is for beneficiaries to be widely defined as a class (to include all or any children, grandchildren and step­children, plus every variety of spouse and partner). Another option would be to establish a more limited class of beneficiaries (e.g. just the children), but to give the trustee power to add people to that class in appropriate cases. A letter of wishes accompanying the trust will give the settlor the chance to set out in detail, and confidentially, all their thoughts about their heirs: about who should (and who should not) benefit and in what circumstances, and what role they may be entitled to take in the business.

The flexibility of these arrangements can be used to achieve many positive estate-planning goals. Equally, they can be used to mitigate risks and threats to family wealth. There are instances where it is necessary to contemplate how the family business might need protecting from the consequences of unhappy marriages in the family, or from beneficiaries in other difficulties. We know that a trust may have some asset-protection value on divorce (although advisors will be aware of the limitations in this area, in the English courts at least). A prenuptial agreement can be another line of defence, and a letter of wishes can make it clear that before any future weddings, the beneficiary in question must enter into a prenuptial agreement if they want to inherit under the trust.

Working with families to establish a clear plan for how assets should be handled is essential to securing a healthy future for the business, and is likely to prevent acrimony among beneficiaries on the death of the principal. Whereas a will becomes a public document when admitted to probate, trust documents and letters of wishes have the advantage of being private documents.

Another advantage of trust structures is the way they can be used as a shelter from foreign inheritance laws that may apply to the family. This is important because many jurisdictions do not allow testamentary freedom and prescribe how assets are divided among beneficiaries. European forced-heirship regimes are one example; Shariah inheritance laws are another. Shariah rules, which mandate an unequal division between sons and daughters, can throw up some interesting cases. In a recent client example, a trust was used (in conjunction with the family’s religious advisor) to achieve a Shariah-compliant result that recognised the particular needs of a disabled daughter in comparison to her financially successful and able-bodied brothers.

Whether a family business is handed down to the next generation as a going concern or sold to allow beneficiaries to enjoy the resultant wealth, there is little doubt that making succession plans well in advance is essential to protecting assets and preventing disputes after death. Advisors need to be prepared to guide their clients through what can be a complex and sensitive process to draw up, and from time to time review, a comprehensive plan that reflects the circumstances of their clients, with their complicated families and businesses.


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