Passing your family business to the next generation – legal guide

Of all the many things that can disrupt or wreck a business, a change in ownership must be near the top of the list. When family politics are added to the mix of a process that is usually fraught with difficulties in any case, it can be an explosive combination.

The specific ways in which businesses are transferred to the next family generation can vary widely according to the circumstances of the business, the family, the tax planning considerations and so on.

Limited company or sole trader? – different approaches

This article will deal mainly with the situation where the business is in the form of a limited company with its shares held by family members. However, there are still many family businesses which take the form of a sole trade or partnership and it is just as important to obtain good quality legal advice when it comes to passing on these unincorporated businesses.

Indeed, it is quite likely that there will be more legal matters that need attending to in relation to the outside world in the case of an unincorporated business, as the legal title to all the business assets will need to be transferred (including the premises, physical assets and “intangibles”).

Preserving existing contractual relationships

The benefit of contracts will also need assigning, as an unincorporated business does not have its own “legal personality”, so that the incoming family members have to take over the contractual relationships, as well as the assets. In the case of partnerships, serious consideration should be given to a proper dead of retirement and notifying the changes in the partnership under the provisions of the Partnership Act, so as to ensure the outgoing family members are correctly released from all liabilities.

In the case of a limited company, in some ways there is less to do in terms of relationships with the outside world, because the limited company will continue to own the assets and hold the contracts. There may be consents needed from any landlords in the case of leased premises and there may also be “change of control” provisions in other contracts, whether with suppliers or for more mundane matters such as leased telephone systems or point of sale equipment etc.

Personal guarantees

It will also be important to bear in mind any personal guarantees of that have been given, such as to the company’s bankers, to ensure that the outgoing family member is released from the personal guarantee and that either the incoming family member provides a replacement guarantee, or if it can be arranged, the company gives alternative security in favour of the bank to avoid the need for a guarantee.

Transferring ownership in small steps

An increasingly common method of transferring ownership of a limited company in stages is for the younger generation to start with a small shareholding and then the older generation may then have their shares bought off them by the company itself, either all at once or in stages, eventually leaving the younger generation holding the only shares in the company. The great advantage of this technique is that the individual family members do not have to take on large personal borrowings in order to finance the transaction.

Tax advice is essential

It is necessary to take tax advice, and obtain the necessary tax clearance from HMRC. This will usually be forthcoming, and although the company may need to demonstrate to its bankers that it can bear the burden of any additional debt needed to facilitate the payment to the outgoing shareholders (and provide the bank with adequate security for any additional borrowings) it is very often the most attractive means of delivering the fruits of their labours to the older generation without overburdening the younger generation.

What legal advice is required?

In terms of the legal mechanics involved, although this is a tried-and-tested formula that should proceed smoothly, it is still a relatively complex process. Companies should ensure that they are instructing experienced advisers well versed in the relevant company law technicalities.

Subject to getting the necessary consents and clearance referred to above, the necessary legal paperwork would normally be prepared in a matter of a few weeks. However, particularly from a tax point of view, the most successful business transfers are the result of careful succession planning carried out with appropriate thought and advice years rather than months before they happen.

This article was written by Ian Hodgkinson, corporate partner at Mace & Jones.