Ensuring business security and longevity with succession planning
29 September 2020 - “Shirtsleeves to shirtsleeves in three generations.” Whilst coined in America, this saying illustrates the long history of family owned businesses failing by the accession of the founder’s grandchildren that impacts such companies everywhere (the general rule being that 30% of businesses survive to the second generation and only 12% to the third).
The UBS/PWC Billionaires report 2019 survey shows that 78% of Asia Pacific UHNWIs have generated, rather than inherited, their wealth so these families have never dealt with the challenges of the transfer of wealth and control that have derailed so many. The same is true for those that do not make it onto Forbes lists but who have made their family financially independent by building their own family owned business.
Yuseff Murphy, Head of Trusts, Asia – Corporate & Private Client, Citco Singapore Pte. Ltd, speaks in this article with Ching Ling Seah, Director, Tax and Private Client Services at Drew & Napier, one of Singapore’s leading law firms, about the importance of forming a business succession plan, what should you consider and a range of other issues.
YM: The first question that people ask themselves when they hear about business succession planning is, how important is it? That tends to mean, what is the worst that can happen if I do nothing? Can you share from your experience how important it is to have a business succession plan and what have you seen go wrong where one was not implemented?
CLS: There are two levels when we speak of business succession plans. At the basic level, we need to plan for how the shares of the family business will be transferred to the next generation. At the next level, we need to consider who will take over the management of the business.
I will deal first with the shares – when a patriarch/matriarch leaves the shares to the children in his/her will, this can lead to share dilution. Take for example, a family with three children and each child is left 33.33% of the family company shares. If one child decides to sell their shares to an outsider, the family will no longer have a super majority. This may be worse in the case of a listed company where a competitor could come in and buy up one child’s shares and coupled with what it has already acquired from the open market, end up being the largest shareholder. I find that this is something that most founders are worried about and hence they would set up trusts where the family company shares are held as a block and cannot be sold unless all the children agree.
As for the management of the business, again this is something that will lead to conflict between family members if not properly thought out. The child with the biggest share of the family business might not necessarily be the best at running the business, but by virtue of his/her shareholding, he/she may have control over the appointment of key personnel. Hence, an ideal succession plan would provide for a particular child/children or even professional manager to run the business and be suitably remunerated while the other members of the family remain passive shareholders and receive dividend income.
YM: Now that we have gauged the value of considering a plan, what are the main areas in which you assist clients to consider and document?
CLS: As mentioned above, we advise clients to consider having the family business shares held as a block to prevent dilution. We sometimes also advise that they sit down with the next generation and discuss difficult issues where the resolution is put into a Family Constitution. Whilst not meant to be legally binding, the Family Constitution’s importance lies in the process by which it is crafted, as issues which the family members may not even have thought of are raised and debated.
YM: A number of clients tell me that they will put in place a succession plan in the future but now is not the right time because of ‘insert reason’. Whilst it is not essential for all businesses to plan their succession now, from what age do you typically see patriarchs/matriarchs start to plan their exit? Are there reasons other than someone’s age that motivate your clients to take action?
CLS: Typically, clients start succession planning in their 50s. The children are usually already part of the family business by then and the parents would have had a chance to gauge their abilities. An expansion of the family business (whether by way of IPO or expanding into a new market/jurisdiction) is also a good time to think about succession e.g. whether to have a particular child head and eventually take over the business in the new market/jurisdiction.
YM: Running a business is tough and requires decisions to be made. Most families will have members who are interested in being active in the company but also those that are not. How can a patriarch/matriarch protect the rights of their other beneficiaries?
CLS: The ones who are not interested in taking an active role in the business can still be passive dividend-receiving shareholders. As for ‘supervising’ the family members who are actively involved and making sure that they do not overpay themselves or cause the company to enter into transactions that dilute the passive shareholders’ stakes, a possibility is to have some of the passive shareholders sit on the board of directors.
YM: A number of successful family owned businesses are so in part because they have hired talented outsiders who have been integral to its growth. How can a business succession plan ensure that those trusted advisors continue to help steer the company?
CLS: Many family companies with outsider talent would have some sort of an Employee Share Option Plan (ESOP) program. These types of plans have a number of customable options; however, all provide for the employee to become a shareholder in the business following successful completion of a proscribed period of time. We have seen business succession plans which ensure that a certain percentage of the company’s shares are put into a trust to continue to fund the ESOP program, even after the founders’ lifetimes.
YM: Many of those that have earned success look to benefit their society through philanthropic giving. How can a business succession plan be used to create and fund a mechanism for continued charitable giving?
CLS: Again, the use of philanthropic purpose trusts here is extremely useful. If a percentage of the company’s shares are held under the trust, then there will always be a stream of income to be used for charity.