Most dreams of creating a family dynasty are dashed within decades, with just over one in 10 family businesses making it from second to third generation, usually because of a lack of proper succession plans, loss of direction or a decision to cash in and do something else with the money.
How to get started
Lawyer Jennifer Maher, of Velocity Legal, says creating a successful succession between generations comes down to careful planning.
“What do the matriarch and patriarch want to pass on?” says Maher, a trusts and estates specialist. “How does that sit with the next generation that might have a different set of values, mindset or even a different perspective on the role of technology?”
Lawyer Jennifer Maher says detailed planning is required for a successful transition. Eamon Gallagher
As Rule, a father of three children, says, “The business interest in our clients has not changed, but we need to continue to adopt and harness new techniques and skills.”
The company’s headquarters in Warrnambool, about 290 kilometres south-west of Melbourne, have been in the same building since 1885.
“Transition between each generation has been smooth and the business continues to provide a good living to the owners,” says Rule, who is hopeful a family member will take over.
Peter Crump, a senior consultant in private wealth at consultancy BDO, says the immediate transition between generations is generally a make-or-break period because of different views on remuneration, technology and strategy.
Hammond Group still occupies the original Warrnambool headquarters in regional Victoria.
Crump recommends parents meet with their children – excluding spouses – to work out how the new generation will continue to grow the business and build consensus.
This might include creating a charter setting out the proposed family philosophy backed by legal and banking advice, and possibly even a non-executive advisory board to discuss issues that will affect the family business.
The FBA’s Sayer adds: “Some families believe a transition can happen over three to six months when it really needs three to six years, if not 10 years, for the next generation to understand their new role and for the transition to be implemented.”
Blood transfusion
The reasons families embark on generational transitions are as varied as the businesses they own.
Claudia Pritchitt, director of PritchittBland Communications, a public relations consultancy for financial services companies, says her father Jim wanted to step back from the business and asked whether she wanted to join. For the next five years, she worked for him, with him and then jointly as chiefs before she took the business over, Pritchitt says.
Phil Dwyer, who ran building and construction company Dwyer Builders, had no plans involving his sons Sean and Christian working for him. But then they asked to enter the family business, and he supervised them through a four-year carpentry apprenticeship before they joined him for 21 years of “good building and getting on famously”.
More than seven out of 10 family businesses are concerned about how to manage a successful transition without disrupting family harmony, says Kirsten Taylor-Martin, national head of family business consulting for consultancy Grant Thornton.
It was Jenna Willett’s professional background in commercial law and government contracts that gave her mother, Jan, a compelling reason to choose her to take over the running of H1 Healthcare.
“It’s great to work with family,” Willett says. “There is an implicit trust between my family members, and it is a lovely way to spend time.
“I think my children are learning about the fun and frustrations of running a family business by listening to their parents talking at the dinner table,” says Willett, who has three children aged three to nine.
Willett, who worked with her mother from the outset, was given the company in a share transfer.
One of her key recent appointments was her brother, Ryan, 39, to develop commercial marketing and strategy for the company, which has annual revenues of about $40 million.
She intends to share equity to retain key employees, including her brother.
“Ryan has only come on board and is happy with the job and opportunities,” says Willett.
Jan says she’ll remain in the background helping to run the office and hoping for “an occasional invite to lunch”.
Structures that protect the family
Velocity Legal’s Maher says transferring a business to family members might involve changes to share structures, amending a trust or tweaking partnership agreements.
Alternatively, it might involve creating trusts or other corporate entities.
Maher recommends a written shareholder agreement for consensus on succession, control and decision-making. This should also include a system for resolving disputes.
“Different share classes may confer different voting rights and remuneration, cementing the future and removing potential for dispute,” says Maher. For example, a certain class of shares might have a right to be involved in major decisions, such as the sale of an asset.
Alternatively, a discretionary trust could hold and manage assets on behalf of family members. The trustee has discretion over how income and assets are distributed to beneficiaries, which creates tax advantages and asset protection.
Maher says the trust deed sets out how it will operate, who can benefit, how benefits will be paid and who is excluded.
The trustee holds the assets for the beneficiaries and enters into contracts on the trust’s behalf.
An advantage is that income can be distributed at the trustee’s discretion to beneficiaries with the lowest marginal tax rates, such as a non-working spouse.
Otherwise, the trustee must pay tax on any undistributed income at the highest marginal rate, which can be 47 per cent plus the Medicare levy.
A trust can also enable a parent to have some control over a business while reducing involvement in daily operations.
But trusts have set lifespans, such as 80 years in NSW and Victoria and 125 years in Queensland.
By contrast, a company has an indefinite lifespan and tax on the undistributed profits is paid at the company rate of 30 per cent.
“This is where restructuring or structuring can be key and collaboration with other professionals, such as tax advisers, is critical,” Maher says.
Taxing issues
Josh Chye, a tax partner with HLB Mann Judd, says transferring a business to family members can create tax issues around realising assets, retirement planning and estate planning.
Different strategies will have different tax consequences for the owners and beneficiaries.
“You need to plan ahead,” Chye says, adding the Australian Taxation Office can provide a private binding ruling that sets out how a tax law applies to a specific scheme or scenario, to assist estimating potential liabilities or concessions.
An ATO spokesman adds: “Though succession planning may not have an immediate tax impact, it is important to include tax considerations in your plan. This will avoid unexpected tax issues arising down the track.”
The alternative is selling the business to an external third party.
Small-business owners aged over 55 years who have owned an asset for at least 15 years are eligible for generous capital gains tax concessions.
Nine wealth transfer tips for family businesses:
- Do the current owners have enough wealth outside the business? Does the next generation have enough to buy them out? Velocity Legal’s Maher adds: “What are the expectations of the next generation? Do they want full control without oversight?”
- Will the outgoing owners cut links, or will they remain involved, possibly undermining the next generation? What happens in blended families? “It is important to mitigate disputes by discussions, mediation or through professional management,” Maher says.
- Can the owners nominate an alternative candidate? This is important if a potential nominee is not interested, says Grant Thornton’s Taylor-Martin.
- Does the next generation have relevant skills and alignment with family values? Also, work out whether there is access to support and mentoring for those taking over the business, says Taylor-Martin.
- What’s the plan if there is a death, disaster or other crisis event?
- Are there agreed family values and a shared vision between the current and next generation? That could involve issues like focusing on product quality or putting the family first.
- Manage communications. “You need to have open communications,” says Taylor-Martin. “Families that do not communicate often assume the worst of each other,” she says. “Family members need to be kept aware where the business is going and stay on the same page.”
- Sort out tax implications. Include potential tax liabilities in the transition plan, warns HLB’s Chye.
- Ensure that succession plans are detailed in wills and regularly updated as circumstances change, adds Taylor-Martin. Only one in three companies have succession aligned with inheritance planning, which could create complex issues, she warns.