4 Steps on how to transfer the Family Business to next generations

How to transfer the family business to next generations?

Timely and proper transferring of family assets requires careful planning and training of successors and documenting the rights and obligations of all family members. This should be based on discussions between qualifying family members in which each express their wishes, worries, objectives and ambitions regarding the family and its joint assets.

In this article 4 key steps are described which allow for a successful transfer of family owned assets to succeeding generations.

Step 1 – When to start the transfer process and who should be involved?

Experience shows that an early start with the inevitable transfer process substantially improves chances of a successful hand over to the next generation. The more involved members of the family are the better. It is essential that they take part on an equal footing and freely express their views. Some first key questions generally are: who is member of the family? Are in-laws –full- members? Are minors? And how about adopted children or those borne outside marriage? Once family- membership is agreed and clear, the next question is how to proceed and with whom?

Step 2 – Identify who wants to succeed and what training is required

Family-heads traditionally decide on their own who should succeed and when, rather than involving family members who can express their views and interests. The patriarch has the final say, but if he wants the transfer to go well and without future trouble, then advance truly open talks between family-members telling what they would want and expect, will certainly help.

For this involving an independent, experienced outsider can be the key. He should start by interviewing all eligible members. Then based on his findings he moderates discussions between family members to agree on the best successor(s). If there are more candidates then each should present their qualities and plans to the family deciding the best candidate. Thereafter a plan to train the potential successor should be adopted, while also the other members should be educated for their role as stakeholder.

But what if no one wants to succeed or has the capacity to do so? Then a non-family member will have to run the family business if it is not sold. To enable that to go well I recommend reading the articles dealing with family governance and family charters. Such documents should allow for outsiders to run the business adequately, while family members can enjoy (financial) rights and accept obligations and limitations.

These documents should also cover subsequent generations and possibilities for them to be(come) executive, and their necessary qualifications.

Step 3 – What rights and obligations should the successor and the other family members have?

Many family businesses fail after a transfer to the 2nd generation and most do not survive a transfer to the 3rd generation! This is because family businesses are generally started by entrepreneurial people who build their business on inspired plans and inspiration. At that stage there are few strict rules and limitations. Profits are applied for the business and with the business grow the experience and know-how of the creator. The founder is often convinced that his children are unable to succeed until they are quite old. A late transfer limits the chances of success!

When kids are finishing school, time has come to start the transfer process by first agreeing and laying down a clear, fair and transparent foundation for the future of the business (or other substantial joint property). Also the rights of all –agreed!- family members now and in future should be fixed, while the candidate-successor should start an intense training.

A committee of wise outsiders can both help to overview the training and protect the position of other future stakeholders as well as the business. So the process must start when the kids are relatively young. It must include discussions on and documenting of rights and obligations of all concerned allowing for a strong business that can be run without undue interference but with informed family members who receive a reasonable, pre-determined income from the joint property.

Step 4 – When should the transfer actually take place and how?

People do not live forever, but experience shows that owners of significant family assets can wait very long with handing over. Most of the time transfers take place upon the execution of a will, the contents of which are frequently a –bad- surprise to the family. Clearly earlier and pre-discussed documentation helps considerably and heads of families should not be afraid to open up on this. It is in fact their prime responsibility to ensure that both their business and his family are ready for the transfer of both the power and the legal title. Structures should be in place to separate power from the legal rights of all stakeholders (see a.o. articles on Foundations and (voting trusts).

There are ways for the older generation to make a transfer so that they can turn the wheel back if things do not work out as planned. However when that route is followed, the step to actually hand over should be taken when the younger generation can do so without undue interference from the elder, but with the possibility to benefit from their experience and knowledge. The new generation will do things differently but not necessarily badly. Also the family constitution should allow for some flexibility and adaptability.

Before the transfer takes place some organisation, committees or boards should be in place so that all members of the family are informed and have an agreed level of influence. Qualifying members of families should be on such boards probably together with 1 or more trusted outsiders who can protect all interests and help resolving potential differences of opinion by acting as mediator or arbitrator.

Fair treatment is essential

It is never easy to hand and to take over but good preparation, transparent documentation and fair treatment of all, is essential!
Most successful people find it increasingly difficult to let go and yet some day, they must! It is relatively easy if there is only 1 child, but when there are more, it is important to start the succession process soon. The successor must be identified and all concerned should be happy with the choice.

Establishing Training, Rules, Rights and Obligations

After that, the training should start while also discussing and establishing the rules, rights and obligations in the family. Such family documentation works best when it is based on broad family-wide discussions so that everyone feels contributor to what must be a fair piece. That will help the successor to run the business well while all others are getting the right information and their fair share out of the successfully transferred family business. https://www.nomoreworries.nl

transfer the family business

Philip van Hilten

No More Worries
+31 6 53 91 97 90
www.nomoreworries.nl
[email protected]

Middle Eastern Family Business: Inheritance Laws and Family Divisions

Middle Eastern Family businesses are challenged by generational change, due to the combined effects of inheritance laws, companies laws, large families and rivalry amongst heirs, challenges which are usually recognized when it is too late.

Internal threats to Middle Eastern Family business

Many Middle Eastern family businesses have been remarkably successful and have become true financial and business powerhouses. Paradoxically, even the most successful families often have dangerous fault lines within, and they fail to recognise potential lethal threats from the inside before it is too late.

Fault Lines Within

Dangers from within the family are subtle and these problems are often more difficult for the founder or other family members to perceive or acknowledge, let alone tackle in an effective manner. But even hairline cracks in the family can widen and invite disaster, particularly where the cracks are disagreements between siblings, the family’s bridge to the next generation.
In 1967 fine corrosion cracking triggered a catastrophic collapse of the Silver Suspension Bridge across the Ohio River in West Virginia, under the twin stresses of low temperatures and high bridge loading. A total of 46 people in motor vehicles died when they fell into the river with the bridge. Likewise, in families, the twin stresses of leadership transition and business pressures can open up differences between siblings or cousins and can lead to the disintegration of the fabric of the family and the business.

The Middle Eastern Cultural Context

Most Middle Eastern family businesses were started by one or two founders who retain ownership of the equity. In the wings awaits a fresh generation of owners, and the number of heirs in the wings is often large, because the culture in the Gulf region favours large families. It is one thing to build a successful business, it is quite another task to imbue every stakeholder with a culture promoting the cohesion and continuity of the family in nurturing and growing successful business enterprises over generations.
Regardless of whether or not a particular sibling understands the family business or embraces the culture, the Middle Eastern inheritance laws guarantee that this sibling will receive an inheritance share commensurate with each other sibling of the same gender, and the Middle Eastern companies laws in the Gulf region guarantee that any heir inheriting shares will have one vote for one share inherited. This combined force of inheritance laws and companies laws means that for most families in business there is absolutely no guarantee that equity and the voting power will be vested in those heirs with the knowledge, ability, character and commitment to lead the family enterprise. Those heirs who do have the training and experience are commonly outnumbered and outvoted by other heirs without these qualities.
The control of family business assets is a key which may unlock a vast reservoir of financial power, social prestige and an enviable lifestyle, so it is natural that there should be rivalry amongst heirs to lead the business. Add the element of sibling rivalry as an overlay and it can be seen that there is real potential for family business disagreements to escalate, particularly at the time when the founder ceases to play an active role.
For these reasons, the inevitable transition associated with generational change and the inheritance process carries with it the potential to develop into an existential threat to the continuity of many Middle Eastern business enterprises. Even where the family business does not break apart, the paralysis of decision-making and the need for complete unanimity in the post-founder era may cause a gradual erosion of the business and asset base.

What Can Middle Eastern Families in Business Do?

The first and the most important thing is to realise that in many cases the past history of the family and its enterprises may not be a reliable guide to what will happen in the future, so something must be done to secure the future.
A family which has a desire to sustain and grow a business together must:

(a) develop a vision;

(b) generate a consensus to embrace the vision;

(c) formulate a plan to take the practical steps to ensure the vision continues (including a succession or stewardship plan); and

(d) implement that plan in an effective way with the best advice.

What Can Families’ Legal Advisers Do?

There are clearly limitations as to what legal advisers can achieve in managing close familial relationships. However, good legal advisers can help, particularly where the atmosphere in the family remains positive. For example they can:

(a) suggest that the family needs to work together to develop the right succession plan and framework of arrangements to promote stewardship, continuity and an orderly transition when generational change occurs;

(b) make sure the right questions are asked and addressed even though the questions may be tough (e.g. should present or future in-laws have a role in the business?);

(c) encourage the creation of safety valves, because if a minority of family members becomes locked into a structure which others control they may feel they have no choice but to fight to break up the business, unless the minority is provided with a fair exit option.

Conclusion

1. Family businesses are vital to the lifeblood of Middle Eastern economies and societies but there is a great need to educate families on the need to put in place the structures and governance platforms necessary for future continuity, harmony and growth in the business enterprise. The hidden economic and social costs of families in business which are dysfunctional are very high, measured in lost business revenues and missed growth opportunities. The family must put in place a leader or a leadership group which can act decisively to move the business forward. Well structured arrangements are needed to head off the ultimately destructive process of open conflict and litigation within families.
2. The challenge for families is to apply the right guiding principles for good corporate governance to build a cohesive family and business dynamic for the good of future generations. Otherwise, the bridge to the next generation will crack and fail, and the family legacy will be lost.

Note: An extended version of this article was first published in “The Oath”, the Middle East Law Journal for Corporates in May 2014. https://www.linkedin.com/in/gary-watts/?originalSubdomain=au

How to best structure Mexican family estate planning?

This article describes certain good ways to structure the estate of a Mexican family.

There are several ways available under Mexican law to organize family estate planning. A family head wishing to distribute the family wealth is able to choose the tool that best suits his or her needs during the life time and even to organize the manner in which personal assets and real estate should be transferred upon death. Moreover, and provided the appropriate usage and/or combination of the alternatives listed below are followed, real estate and personal assets could be organized in the best interests of the family and its members.

Organising Mexican Family Estate Planning

Gifts: In Mexico, this is a contract whereby some or all current assets are transferred without consideration. It can be effective from the date of execution, or it can be conditional upon the fulfillment of future events, and generally speaking, it can only be annulled in specific cases set forth in the law. Gifts of real estate and other goods (including cash) exceeding $400 dollars (roughly) must be formalized before a notary public. As for tax effects, donations among close relatives (parents, children and grandparents) are not subject to tax regardless of the amount and tax residency (certain formal requirements have to be fulfilled).
Usufruct: This gives the right to use and enjoy someone else´s real estate or shares in a company. It includes the right to give the use of any proceeds from the property to an individual or a group of individuals, simultaneously or successively. It can be granted by contract or by will and for a fixed period of time or during one´s lifetime. It is effective from when it is granted or it may be conditional as well. In some cases, donors keep for themselves the usufruct for life in order to use the property despite the fact that legal title has been transferred. As for the tax effects, granting a usufruct over real estate or over shares is considered as a transfer of property and thus it is taxed unless the usufruct is granted by a gift among close relatives (as previously defined). A usufruct of real estate has a positive tax impact in some circumstances, such as for purposes of the real estate transfer tax in some states in Mexico and the Federal District, in which the consolidation of the property (when the usufruct is extinguished and the property is fully acquired) would not lead to the payment of further taxes.
Life annuity: By means of this, the obligor agrees to periodically pay a pension during the life of one or more specific persons in exchange for either the payment of a sum of money or the transfer of personal or real property whose title is forthwith transferred to the obligor. It can be granted during a lifetime and by will. As for the tax effects, a life annuity has the advantage of not being taxed in the recipient hands if received as alimony.
Homestead (also known as a family estate): This is intended to provide economic protection to the family. A dwelling occupied by its owner and his or her family is exempt by law from seizure or attachment for debt. Title is transferred to the members of the family who must use it for living in. Under Mexican law a homestead can only be created over assets of a certain value and once it is created, no other homestead can be established. As for the tax effects, a homestead has no tax effects unless the real estate in question is effectively transferred to a relative and even in that case, a tax exemption (as a gift among close relatives) may apply.
Fideicomiso (in civil law this is similar to a Trust): Under a fideicomiso, the settlor (fideicomitente) transfers certain assets to a fiduciary or trustee (in Mexico only banks or financial institutions are authorized to act as trustees) to be used or managed for a particular lawful purpose for the benefit of one or more beneficiaries (fideicomisarios). Title is transferred to the trustee who must act according to the instructions of the settlor and even of the beneficiaries. As for the tax effects, the transfer of property to a fideicomiso have no tax effects unless it is irrevocable. Generally, fideicomisos constituted for estate planning purposes are revocable, thus no tax effect is triggered initially. A testamentary trust can be constituted by will. Also, it is possible to use foreign Trust for estate planning purposes, which are commonly used for asset protection and confidentiality.
Will (also known as testament): By a will a person establishes the way his or her assets are to be distributed upon death and appoints the individual in charge of managing them until transfer to beneficiaries. In general terms, the testator is entitled to distribute his or her assets as a whole (in which case the beneficiaries are called heirs), by way of specific gifts (in which case the beneficiaries are called legatees or devisees), or using both (heirs and legatees or devisees). Either way, the testator appoints those who will receive the personal and real property as well as proportions and is allowed to establish conditions to be met by the beneficiaries as well as encumbrances and charges over assets. Mexico follows the testamentary freedom doctrine and thus there is no requirement that a testator must leave his or her estate or a portion of it in any particular way. A will can be revoked by its author or substituted by a new testament and can be made regardless of the family situation that may prevail after death. However, exceptions to its validity are clearly stated by law and must be observed in order to minimize the risk of its being challenging. As for the tax effects, property is transferred tax free among Mexican tax residents provided that certain formal requirements are met (i.e. filing a tax return) but foreign residents for tax purposes [[As a general rule, Mexican citizens who change their dwelling in Mexico to abroad are no longer considered as residents in Mexico for tax purposes. Conversely, foreigners moving their dwelling from abroad into Mexico become tax residents for tax purposes.] (even if they are Mexican citizens) are subject to tax of 25% on the gross amount.
International wills: Although Mexico has not made any international treaty regarding wills granted outside of Mexico (international wills), such documents would be effective in Mexico whenever granted in accordance with the law of the country where it is made. Consistently, Mexican domestic legislation recognizes legal situations created in another country if valid under the law in force therein. Furthermore, civil and procedural laws provide specific rules for foreign documents to be enforced in Mexico and several conventions related to international assistance in legal proceedings are currently in use. As for tax effects, international wills are taken into account for purposes of the tax exemption on inheritance by Mexican residents for tax purposes.

A family head wishing to leave his business to certain family member(s) can use or combine the aforementioned tools to achieve that purpose. Thus the shares of the company can be included in his will, may also be given as a gift during lifetime, grant the usufruct over the economic rights of the shares (right to receive only dividends) or even transfer the shares to a Trust or Fideicomiso for its management and disposition upon death. Usually Fideicomisos for controlling shares (Fideicomisos de control accionario) are used by families for keeping the control of the shares within the family and set up rules for its disposal. https://basham.com.mx/en

Important things to know when organising the Family Business

Organising the Family Business

Family reunions and family council

Transparency fosters trust. As former US Supreme Court Justice Louis D. Brandeis once noted, “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants ….”

This holds true for families as it is applicable to the sound management of large commercial companies. The place where this transparency can be achieved in families is the family reunion, a gathering of family members at regular intervals during which information is provided to the family members on the ongoing business, important events and future developments.

In particular if families are large and where the family decides to include spouses and children (of a certain age) to be admitted to the family reunion it makes sense to create from the family body a committee charged with the organization and running of the family reunions. The formation of such a committee – or family council – should be based on the family charter which should define its duties, exact composition and its decision-making powers and the requisite procedure.

In its function as the link between the business and the family, the family council has the duty to disseminate information about the business to the family members at the family reunions. The family council should draft an information policy regarding the development of the business. Holding family reunions and involving younger generations from a suitable age goes towards establishing a healthy understanding and identification of these persons with family business.

The family council is best made up of family members with a direct stake in the business or who are actively involved in the management of the business. Choosing a chairperson for the family council can be a challenging task.

The person should be someone that enjoys wide trust within the family and who has a large measure of experience in the family business and who can also communicate well with the various groups making up the family reunion. Since it is also the chairperson’s calling to promote compromise and facility consensus among the family members it is advisable not to appoint the CEO of the family business to this position. In many instances the CEO might lack the objective distance to the business necessary to achieve a healthy compromise.

Information and communication

In order to ensure positive relations within the family and the environment in which the family business operates (inner realm being the family and the outer realm being society at large), a sound and honest information policy should be devised and adhered to. Depending on the size of the family involved such communication may take the form of regular dinner table discussions or the distribution of updates in the form of family newsletters.

Both formal and informal communication should find their place. Discussing family relevant business issues at an early stage and with the necessary frankness are an important part of avoiding or diffusing differences of opinions and conflicts becoming insurmountable.

Taking into account that the perception of a family business by outsiders and the public at large has significant influence both on the reputation of the business but also on the loyalty of the family members to the business it is important to also develop a coherent and positive communication policy to the public. By communicating major decisions to the public, the family can increase its credibility and gain the trust of the general public and its customers.

At the same time the advantages of a positive communication policy need to be balanced against the need to keep confidential certain valid business interests, trade secrets and the will to safeguard the family’s privacy interests. Where no clear and well supported communication policy can be achieved internally, it is advisable to include an external chairperson or mediator in the process. https://www.prager-dreifuss.com/

These archived articles are written by authors no longer participating in the Family matters on line project. These articles may still be relevant however. If you want more information please do not hesitate to contact us and we will try to put you into contact with the original author or another expert in family matters.