Considerations for business owners when estate planning
Around 70% of businesses fail as they pass from the first generation to the second generation – not only affecting legacy and reputation, but also diminishing the equity in the company or business.
Business owners must carefully consider what will happen to the business following their death to protect the interests of the business and / or secure the futures of their family.
A professional can help you execute your wishes through diligent estate planning, and their knowledge and experience can assist you in considering the possible eventualities. Various examples of these contingencies have been included below – some may not have even crossed your mind.
If you want to be confident that you have considered all possible factors and are fully informed when carrying out your own estate planning, it is essential that you use the services of a trusted professional.
Who do you want your shares / business assets to go to?
- Will it be a family member or a co-owner of the business?
- If family members are to continue running the business, do they have the requisite skills, knowledge and experience?
- Do they have a genuine interest in taking over the business?
- Would their appointment lead to conflicts with the surviving owner as to how the business operates?
- Would it be worth appointing other directors during your lifetime to manage the business in the future?
- Will the surviving owners have an option to purchase shares from your estate? *
- Could you use different share classes, where the shares carrying voting rights go to the surviving partners, but the shares your family inherit carry only dividend rights? *
*See the ‘Limited Companies – Look Out!’ section below for more information
Are you planning an exit from the business or retiring?
- Would it be better for the business to continue generating a profit following your death to provide an income for your family?
- Will the sale / disposal of shares trigger a large CGT liability?
- Can you make use of any available IHT / CGT reliefs?
- Do you need to consider inheritance tax planning if you were previously relying on BPR to keep your estate below the IHT threshold?
Business owners considering an exit should also keep in mind that BPR may be lost once they are no longer involved in the business; this should be carefully considered for inheritance tax planning purposes before exiting the business!
Limited Companies (“Ltd Cos”) – Look out!
It is a common misconception that a person holding shares in a Ltd Co can transfer their shares at their discretion, whether that be by way of a lifetime gift or through your estate. However, this is not the case.
The transfer of shares in Ltd Cos are ultimately governed by the company’s constitutional documents (“CCDs”) such as the articles of association and shareholders agreements. Typically, CCDs will take precedence over any wills or trusts dealing with the shares as the assets belong to the company.
The CCDs must align with your estate planning documents to avoid any problems when moving your shares following your death. For example, the CCDs may grant other shareholders pre-emption rights (rights giving existing shareholders first refusal over any shares that are issued or transferred).
Alternatively, there may be compulsory transfer provisions or a cross-option agreement in place where surviving shareholders have the ability (and can even be required) to purchase shares held by the incapacitated or deceased shareholder.
Another example is where the articles of association or shareholders agreement gives directors authority to refuse to register a transfer of shares – meaning they may have the right to refuse the transfer of your shares to your intended beneficiary (subject of course, to a variety of other factors). Although it is fairly uncommon for directors to possess this right, it highlights the importance of aligning your estate planning with the CCDs.
Speak to a professional who can review the company structure to ensure that all the CCDs are well-written, unambiguous and aligned with your estate planning wishes. For instance, a comprehensive shareholders agreement will deal with the ownership and transfer of shares, shareholder disputes and will set out what happens if a shareholder becomes incapacitated, dies or retires.
Formally setting out these eventualities in the CCDs not only protects the business, but also allows shareholders to carry out effective estate planning with confidence, as they can be safe in the knowledge that their business assets will pass to their beneficiaries in harmony with the company’s constitution.
Using different classes of shares
When done correctly, different share classes can be a valuable tool when it comes to estate planning; it can provide peace of mind that the business will continue to thrive whilst your beneficiaries simultaneously reap the rewards.
Most companies have only one class of shares – typically called ‘ordinary’ shares. The main issue with the exclusive use of ordinary shares is that the rights of all shareholders (mainly dividend and voting rights) are indistinguishable.
In terms of estate planning, using only one class of shares may result in an unsuitable beneficiary inheriting your shares which carry equal voting rights to the other shareholders. This could lead to disputes with the other shareholders, especially if that particular beneficiary has no interest, knowledge or experience in running the business.
An unsuitable beneficiary may inherit a disproportionate number of shares and be given control over the company (particularly if they inherit over 50% of the company’s shares). In the worst-case scenario, this could lead to the eventual demise of the company.
Creating different classes of shares (e.g. by reclassifying existing shares) can help avoid these issues and can provide flexibility to a company and its shareholders.
The simplest example would be a company (with shareholder consent) reclassifying their existing shares into alphabet shares (i.e. ‘A’ shares and ‘B’ shares). The ‘A’ shares would carry both dividend and voting rights, whereas the ‘B’ shares would carry dividend rights only.
Shareholders can put documentation in place setting out how the shares are to be distributed upon their death. For example, a shareholder may wish for their children to inherit their ‘B’ shares (dividend rights), with their ‘A’ shares (voting and dividend rights) passing to the surviving shareholders.
Business Property Trusts
An alternative to using different share classes may be to incorporate a business property trust (discretionary trust) into your will. Business property trusts can be an effective way of maximising BPR by transferring all your assets that qualify for BPR into a trust fund.
The trust will be created upon your death and the legal title to the assets will then belong to the trustees. These trusts work in a similar way to using share classes, as the beneficiaries (benefiting from the income of the trust) are not given any control over the shares and the associated voting rights – such control is instead given to the nominated trustees.
Family Investment Companies (“FICs”)
FICs are becoming increasingly popular as a substitute for trusts. This is usually because FICs are companies, and they are taxed as companies – whereas trusts are subject to their own tax regimes.
FICs can be a good way for the founders (parents) to manage their family wealth, as family assets / investments can be held in an FIC (company) before the company is transferred to their children.
FICs are usually set up as limited companies, with much simpler structures than trusts (although trusts can offer more flexibility and control). Like trusts, FICs can be used to ensure that little to no IHT is payable on the transfer of business assets by claiming BPR.
Trusts and FICs have their own unique benefits, and each individual has their own objectives, so it is best to take advice to determine the most effective estate planning tools for your personal needs.
The different mechanisms outlined in this series of articles only briefly touch on the intricacies of tax and estate planning. The law surrounding estate planning and taxation is constantly evolving, so it is important to regularly review your estate planning documents and update them to reflect any new tax laws or changing personal circumstances.
The combination of estate planning tools used in each case will depend entirely on individual circumstances. Solicitors, accountants and financial advisers can all work in tandem to ensure that your estate and business will pass to your chosen beneficiaries in the most tax-efficient way possible (whilst remaining compliant with tax laws and the company constitution).
Supplementary to proper tax and estate planning, it is always advisable for business owners to have a clear succession plan in place, laying out smooth transitions in ownership, operations, leadership and management.
If you would like advice concerning your tax or estate planning, or in connection with your existing estate planning documents, speak to one of our Private Client solicitors today and find out how we can help. Please contact us by telephone on 03456 465 465 or email enquiries@rotherabray.co.uk.
Disclaimer: This blog is for information only and does not constitute legal advice. If you need legal advice please contact us on 03456 465 465 or email enquiries@rotherabray.co.uk to get tailored advice specific to your circumstances from our qualified lawyers.
