Plan for success(ion): Succession planning for family businesses

Succession planning is a critical aspect of any family-owned business, ensuring a smooth transition of ownership and management from one generation to the next. As families navigate the complexities of this process, they should consider various legal structures that can promote continuity.

Among the most effective tools for succession planning are trusts, family investment companies and family limited partnerships. This article will explore each of these structures, highlighting their unique benefits and the different tax regimes which apply.

Trusts: safeguarding wealth and ensuring continuity

Trusts can play a significant role in succession planning. By establishing a trust, families can control who benefits from their assets for years to come, providing a framework for protecting wealth across generations which often helps to reduce potential conflicts among the family. Trusts also provide protection against creditors and divorce, ensuring that the assets are preserved for future generations.

A trust can hold assets in the same way as any individual, meaning business assets, including shares in a family company, can benefit from the additional protection a trust affords. An additional benefit is that shares held in the names of trustees can help maintain operational stability for the company during the transition between generations since ownership of the shares remains with the trustees and is untouched by family bereavement.

Another benefit is the flexibility a trust can provide. For example, discretionary trusts allow trustees to control the timing and amount of any capital and income distributions among beneficiaries. This adaptability means the trustees can respond to changing family dynamics, ensuring that the trust continues to meet the family’s needs in the long term.

It is worth noting that trusts fall within a separate tax regime and the trustees are likely to pay inheritance tax, capital gains tax and income tax. These are distinct from the taxes individual family members would pay. The rate of tax also differs. For inheritance tax, the trustees may pay up to 6% on the value of the trust every 10 years as opposed to a potential 40% charge on the death of assets owned by an individual. For income tax, the trustees will pay the ‘rate applicable to trusts’ which is a flat rate of 39.35% on dividend income and 45% on any other income.

The taxation of trusts is a complex area. Please contact our private wealth team if you require specific advice based on your individual circumstances.

Family Investment Companies: control and tax in a corporate environment

Family Investment Companies (‘FICs’) are an increasingly popular way to structure family wealth and resonate highly with those who are already familiar with corporate structures through their professional work.

FICs can be structured in a way that provides different benefits to different family members. A common arrangement is to have “alphabet shares”, which are different share classes labelled A shares, B shares, and so on. The rights attaching to each share class can vary, so for example a certain share class may enjoy the right to receive dividends, even when other share classes do not. Certain share classes might also be given the right to appoint a director to the FIC board, to participate in the day-to-day running of the FIC, and this person could be either a trusted advisor or a family member. The voting rights attaching to each share class can also be weighted, to allow for control to be exercised by senior family members, and these rights can be amended from time to time to ensure the setup accords with changing circumstances. Corporation tax is charged on FIC profits, and dividends are chargeable for tax depending on the underlying income tax rate of the individual, with a top rate of 39.95% for additional rate taxpayers.

Family Limited Partnerships: control and tax benefits

Family Limited Partnerships (‘FLPs’) are another effective legal structure for succession planning and offer something of a compromise between trusts and FICs.

In FLPs, senior family members create a partnership where they manage family-owned assets for the benefit of the wider partners.  They commonly act as general partners, maintaining control over the business, whilst other family members serve as limited partners. The limited partners may not be involved in the day to day running of the partnership and instead only receive a right to a share in the profits.

In addition to separating the rights to capital and income of the business, individual family members can hold the capital that they have contributed in their own capital accounts. This ensures fairness amongst the family members and avoids the loss of asset control that might arise if a right to the capital of the business were to be granted to a family member.

As with trusts, one of the most significant advantages of FLPs is asset protection. This is particularly valuable for family businesses that may face legal challenges related to their operations, or for particular family members who may have unrelated liabilities which could affect their stake in the family business.

Furthermore, FLPs offer specific tax advantages. When limited partnership interests are gifted or sold, they are often valued at a lower price than the underlying assets, resulting in potential tax savings. This can be especially beneficial for families looking to mitigate their inheritance tax liabilities. Additionally, FLP’s are “tax transparent” as versus a company, meaning that tax liability attaches on the income paid out to partners, rather than corporation tax being charged on the business’ profits and subsequent income tax being charged on the dividends paid out to shareholders.

FLPs also facilitate smooth transitions of ownership. As family members get older or become less involved in the business, the management of the FLP can be gradually transferred to the next generation. This avoids abrupt changes in leadership and management, ensuring that the family business remains stable during the transition.

Caution must be taken when setting up an FLP to ensure the resulting structure could not be classified as an unlawful collective investment scheme. This is an easy mistake to make if sufficient care is not taken when drafting the documents establishing an FLP, and legal advice should be taken on the mechanisms for adding or distributing assets from the FLP.

Conclusion

Succession planning is essential for the long-term success and viability of family-owned businesses. Trusts, FICs and FLPs are important legal structures that can help families navigate the complexities of transitioning ownership and management. Every family is different, and our private wealth team and corporate transactional team are experienced in helping families to implement the most effective strategies for their specific needs.