How to make a splintered family business work

What happens when the next generation is split into family factions? Having kids from multiple marriages can fragment a family business if legal safeguards are not in place.

Family business succession planning can be complicated enough where the owner has children from only one marriage, let alone where there are more than one set of children.

It may be that some members of the next generation are actively involved in the family business and wish to acquire equity, while others have no interest in the family business other than expecting a fair inheritance or ongoing support.

How can the owner pass on control of the family business without inadvertently laying the foundations for a messy and costly legal battle after his or her death? And what can be done to ensure the transition is as smooth and successful as possible?

Consult and identify interested children

Don’t assume you know which members of the next generation are interested in running the business – take the time to discuss it privately with each of them and consider employing the ones who are interested. It should also be made clear only family members who have suitable experience in or outside the business will be considered for leadership roles. This ensures that the next generation acquires practical experience without the pressure and expectation of being the guaranteed successor. It also gives the owner an opportunity to evaluate whether the child is suited to running the family business and how to structure the succession.

Keep the conversations on the succession plan regular and open with all family members. Children in blended families often vary substantially in age and may have had very different upbringings. This may affect their view of the owner’s succession plan. Regular dialogue will help them feel they are involved in the plan and that their views have been considered. This may also limit grievances after the owner’s death and, in turn, limit legal disputes. 

Passing control

Passing control, in part or in full, during the owner’s lifetime may assist in ‘bedding down’ the succession plan and allow the owner to act as a ‘guardian’ during the transition phase when he/she is actively able to assist the next generation. This may be particularly important in blended families where the owner is likely to be the common link between all of the children. It may also limit any claim on the owner’s estate, as discussed below.

Will

If the owner gives control of the family business through a will, then the relevant child or children may not provide consideration for acquiring control and this would need to be factored into how the inheritance is divided. Provided that the owner has other assets to sufficiently provide for their other children, this option may be the simplest approach.

If the owner doesn’t have sufficient assets to fairly compensate their other children, then a buy option can be built into the will. The will can be very specific about the terms of the buy option or leave certain decisions up to the executors’ discretion.  It can contain mechanisms for determining the sale price and specify dates by which the option must be exercised and completion must occur. If the child or children do not have sufficient funds to pay, then loan terms can also be specified.

The buy option may be preferred where the balance of the owner’s estate is given to their surviving spouse. In these circumstances, the child or children acquiring control of the family business would receive part or all of their inheritance ahead of others, which may cause friction within the family. In blended families, the friction may be increased by the surviving spouse attempting to cut out their step-children from receiving their inheritance. These issues can be mitigated by various methods, such as the owner granting a life interest in certain assets to their current spouse and giving the remainder interest to their children.

Family Charter

A family charter is a document that sets out the interaction between the family and the family business and aims to preserve the wealth by implementing appropriate governance, similar to the constitution of a publicly listed company.

Documents like this are at their most important when there a several families involved in the business. Particularly if there has been bad blood in the past, as is often the case with multiple marriages (The constitutions solution to governance clutter, May 1, 2013).

Claims against estates

Any succession plan must take into account potential claims against the owner’s estate on the basis that adequate provision has not been made for a particular person. In blended families there may be an increased risk of such a claim.

In Victoria, any person can make a claim on an estate. Whether a claim will be successful will depend on a variety of factors, which this article will not explore. Specialist advice should be sought if this is a concern.

Claims are usually only made against an estate, which means assets gifted during the owner’s lifetime or assets held in a trust are outside the scope of a claim. Therefore, if the owner passes control of the family business during their lifetime, subject to due consideration of tax consequences,  that may limit disputes within the next generation about the family business. This strategy does not apply in New South Wales, where courts can order that property disposed of before death form part of a ‘notional’ estate for the purpose of determining a claim.

Regular review

Succession planning can be seen as a daunting and difficult task, especially in blended families. However, it is simply an element of business planning, such as preparing annual budgets and accounts. Succession planning can assist the owner in implementing sound governance and procedures, which may also result in greater productivity, transparency and business growth. If no succession plan is put in place, then all of the owner’s hard work may evaporate very quickly after passing away. Particularly in blended families, where relations can easily descend into legal conflicts.

Once a succession plan is developed, it is imperative that it’s regularly reviewed and revised due to changing circumstances, such as family relationships and business growth. This may require specialist legal advice together with the family lawyer and accountant. The cost of implementing and regularly reviewing a good succession plan will be far outweighed by the risk of messy legal battles following the owner’s passing, the risk of which may be increased in blended families.

Laszlo Konya is a senior associate at Pointon Partners.