Best Practices for Succession Planning – how do you do it best?

It is commonly known that most family wealth does not last past the third generation – that money earned by the first generation is depleted by the time it reaches the grandchildren.

Typically, the first generation builds and generates this wealth, with the second enshrined with the role of maintaining it. By the time we reach the third generation, sadly such wealth is unlikely to continue. A primary reason for this is that the third generation is born into wealth and do not have the difficult task that the first generation had in having to build a business from the ground up.

This is why it is critical that succession planning should be taken seriously, especially in the context of changing family dynamics. A fear of what the future holds as the family business passes down the generations should be of concern to ageing CEOs who have spent their lifetime building said family business. Understandably, when one has dedicated their life to building a successful business, one wants to see it continue to flourish after their lifetime.

What are the best things one can do to plan their succession in the context of ever-changing family dynamics? This article pinpoints four critical success factors that family businesses must consider to ensure future success.

Formulate a family governance structure and constitution

A family governance structure can allow for clarity and provide a framework for decision-making. It is important though that such a structure has methods for dealing with disputes between family members in the business. The risk of family conflict can break down any structures in place if there are no measures designated to deal with disputes effectively. Further, when an ageing CEO does pass away and the family business is inherited by multiple heirs, this can lead to a fragmented ownership of the business, which can create the potential for disputes between shareholding family members. A family constitution is a good way to mitigate against this. This is a document that sets out the foundation of the family’s visions and policies with respect to the business. The constitution should include clear and defined roles and responsibilities, provide processes for decision-making, dispute resolution mechanisms and a settled procedure for succession within the business.

Prepare a Will and Lasting Powers of Attorneys (“LPAs”)

A key part of succession planning is the preparation of a Will, especially for the head of the business. It is best to prepare a Will early and to then keep it under review and regularly updated so that changing family dynamics and circumstances can be accounted for. Ultimately, this will assist in ensuring that the wishes of the head of the business are less open to challenge. The Will should clearly delineate the passing and distribution of business assets. Lack of clarity in a Will leaves the estate of the head of the business vulnerable to legal challenges.

From a capacity perspective, preparing a Will earlier rather than later will rebut doubts as to whether the testator or testatrix was lacking in capacity. Similarly, it would be prudent to prepare LPAs with respect to financial decisions, deploying the most trusted individuals to act as attorneys. This will ensure that one’s finances are in safe hands by people who can be trusted to make decisions on one’s behalf if he or she were to become incapacitated, particularly in the context of a family business.

Trust in trusts

Trusts are a vehicle which can be used to manage, preserve and protect business assets. Trusts are useful for business owners who may wish to safeguard assets and can in some circumstances protect family wealth from being divided in divorce settlements. For family businesses, trusts can be an effective means at providing a smooth transition of management and ownership of the business.

Depending on the type of trust created, they can allow a settlor to guide how and when a beneficiary is entitled to capital, which can provide a useful mechanism to control the distribution of assets. Discretionary trusts in particular can provide business owners flexibility to adapt to changing family, societal and legislative circumstances. Critically, a discretionary trust gives a trustee discretion as to whether, if at all, a beneficiary is to be distributed any wealth from the structure and when the most appropriate time to do so is. This may be especially important for a business owner considering when it is most appropriate for their children or grandchildren to inherit wealth. Necessarily, therefore, trusts are futureproof and allow for successive generational planning in that they can provide for future generations. If a settlor chooses a fiscally sensible and trustworthy professional trustee to manage the trust through the generations in line with the wishes of the settlor, this can mitigate against the risk of wealth collapsing by the third generation.

Navigate the uncertainty of the “non-dom” regime

This article by no means proposes to explain all of the proposed changes. However, a common planning technique for current non-UK domiciled individuals is to set up trust structures for, amongst many reasons, succession planning purposes. Irrespective of whether the Conservative or Labour Party win the election on 4 July 2024, one certainty amongst all of the uncertainty surrounding the election is that the “non-dom” regime will be abolished. The exact form this takes is unclear at the time of writing. However, when the regime is abolished, the tax charges for setting up a trust structure may be significantly higher.

It is hoped though that the final form of proposals will allow international families with international businesses to still be able to make use of the succession planning benefits of wealth structuring whilst also, in ensuring fairness, paying tax.

This article was first published in Family Office Magazine in July 2024.