Keeping the Business in the Family: Protecting Shares as They Pass to the Next Generation
You have spent years building the family business and have decided the time is right to start passing shares to the next generation. But there is another question worth asking: Once those shares leave your hands, where could they end up next?
If the intention is for the business to remain in the family for generations to come, it is worth thinking beyond the initial transfer. What happens if a family shareholder wants to sell? What happens if they die or divorce? And how much control do you actually want to hand over now?
These are questions that are much easier to address before the shares change hands.
Giving shares means giving rights
A share isn't simply a percentage of the value of a company. Depending on the rights attached to it, a shareholder may be entitled to vote, receive dividends and participate in the proceeds if the business is eventually sold.
So before transferring shares, decide what you actually want to pass on.
Do you want the next generation to share in the future value of the business?
Should they receive dividends?
Should they have voting rights immediately?
Or do you want to retain control while the transition takes place?
Different classes of shares can sometimes be used to give shareholders different rights, allowing ownership and control to evolve at different stages.
The important thing is to work this out before you start transferring shares.
What if they want to sell?
Imagine you transfer shares to your three children. Ten years later, one decides they want out.
Can they sell their shares to anyone?
Could an outside investor become a shareholder in the family company?
Or should the other family shareholders have the first opportunity to buy them?
The company's articles of association and shareholders' agreement can set out what happens when someone wants to transfer their shares, including who they can be transferred to and whether they must first be offered to existing shareholders.
For a family business, these provisions can be particularly important.
If there are people you don't want owning shares in the future, don't wait until someone wants to sell to deal with it.
What happens if a shareholder dies?
Death creates a different issue.If a family member owns shares and dies, what happens to them?
A Will is an important part of the answer. It allows a shareholder to decide how their assets should pass rather than leaving the position to the intestacy rules.But simply leaving the shares to a particular person may not always be the best outcome for the business.
For example, the remaining shareholders may want to continue running the company without the deceased shareholder's beneficiaries becoming directly involved in the business. At the same time, the deceased shareholder's family may prefer to receive the value of the shares rather than inherit an interest in a private company.
This is where a cross-option agreement can be particularly useful.
Put simply, a cross-option agreement can give the remaining shareholders the option to buy the deceased shareholder's shares and give the deceased shareholder's estate the option to require the remaining shareholders to buy them.
The arrangements are often supported by appropriate life insurance, providing funds to help finance the purchase.
The practical result can be a much cleaner outcome: the shares remain with those continuing the business, while the deceased shareholder's family receives value for them.
What about divorce?
This can be a more difficult conversation. You may be comfortable giving shares to your son or daughter. But what happens to that interest if their marriage later breaks down?
Business interests can become relevant in divorce proceedings. Where shares have significant value, that can create difficult issues not only for the individual shareholder but for the wider family business.
One option families may consider is a pre-nuptial or post-nuptial agreement.
These agreements can record how a couple intends particular assets to be treated if their marriage ends. Although they are not automatically legally binding in the UK, courts can give significant weight to appropriately prepared agreements where the circumstances and terms are fair.
For a family business, that might include an intention that inherited or gifted business shares should remain separate from other matrimonial assets.
It may not be the most comfortable conversation to have before transferring shares. But neither is dealing with uncertainty over ownership of the family business during a divorce.
Could a trust have a role?
Passing shares to the next generation does not always mean transferring them directly to individual family members.
In some circumstances, a trust may form part of the family's wider succession and estate planning. Rather than shares passing outright to an individual, they may be held by trustees for the benefit of specified family members.
That can provide greater flexibility over how family wealth is managed and passed between generations and may help avoid ownership becoming fragmented between an increasing number of individual family shareholders.
For example, a family may want future generations to benefit from the value created by the business without every beneficiary necessarily becoming a direct shareholder or having a role in running the company.
Trusts can also be useful where beneficiaries are young or where a family wants to put a longer-term framework around how assets are held and managed.
But trusts come with their own legal, tax and administrative considerations. They are not a default solution for every family business. The important question is whether a trust helps achieve the family's particular succession objectives.
Put the pieces together
There isn't one document or structure that deals with all of this.
Depending on the family and the business, succession planning might involve:
Different classes of shares and appropriate share rights;
Articles of association;
A shareholders' agreement;
Wills and estate planning;
Cross-option agreements and life insurance;
Trusts; and
In some cases, pre- or post-nuptial agreements.
Tax advice should also be taken before shares are gifted, transferred or placed into trust.
The objective isn't to make the family structure unnecessarily complicated. It is to make sure the arrangements work together and reflect what the family actually wants to happen.
Before you pass the shares
If you are thinking about transferring shares in the family business, ask:
What rights am I giving away?
Do I want to retain control for now?
Can the shares be sold outside the family?
What happens to them if a shareholder dies?
What happens if a marriage breaks down?
Could a trust have a role in the longer-term succession plan?
And what happens when the next generation eventually wants to pass their interests on again?
Passing shares to your children may be the first step in succession. Making sure the ownership arrangements can stand the test of time is the next.
How Daly McCormick can help
At Daly McCormick, we help family businesses put the legal arrangements in place to support long-term succession.
That can include reviewing share structures, articles of association and shareholders' agreements, planning transfers to the next generation, putting appropriate cross-option arrangements in place and considering how the corporate arrangements fit alongside Wills, trusts and wider family planning.
Working alongside your accountants, tax advisers and other professional advisers where appropriate, we can help you plan not just who gets the shares next, but what happens to them after that.
Your business. Our legal expertise.
Dungannon, Belfast, Omagh
02887441840
Disclaimer: The information provided here does not, and is not intended to, constitute legal advice. Instead, the information and content available are for general informational purposes only.
