Don't let a 'rags to riches' family business split at the seams

SUCCESSION PLANNING has suddenly become one of the key issues for owner-managers.

Many entrepreneurs hope that their business is something they will be able to pass on to their children. All too often, though, the family's "rags to riches" story ends with ". . . and back to rags again".

A combination of poor planning, tax problems and family conflicts can conspire to prevent the original founder's heirs ultimately seeing the full value of the business.

American research shows that only one in three family-owned businesses survives from the first to the second generation, and a mere 15 per cent make it to three generations. The European Commission estimates that around 1.5 million small businesses in Europe run the risk of failure through succession problems.

In Scotland, around 90,000 businesses are owned and controlled by families. According to the Centre for Family Enterprise at Glasgow Caledonian University, half of Scotland's family firms will pass into new hands in the course of the next 8-10 years. More than 90 per cent have no documented plan for succession.

Succession problems can come in a number of forms, but most involve a failure to plan and an inability to communicate, even between members of the same family.

One of the commonest is simply leaving it too late. Many entrepreneurs are reluctant to share command until they are ready to retire. As a result the next generation may not be prepared.

Parents running a family business frequently make assumptions about what their children want, but by the time succession becomes an issue, the offspring may have very different career plans. There is a tendency for fathers to underestimate the contribution that daughters might make, and it is easy to overlook the fact that key employees, not family members, may be better equipped to manage the business.

Tax presents a number of pitfalls. Done wrong, the handover can present new owners with a large tax bill.

As a result of changes to capital gains tax introduced in this year's Budget, from April 1999 business owners will no longer be able to claim full retirement relief. Instead, there will be incentives for people to hold on to assets for at least 10 years.

Chris Christou, chairman of the small business committee of the Association of Chartered Certified Accountants (Acca) and principal of Leigh Christou, in Coventry, says: "Many proprietors will be rushing to claim retirement relief this year. In most cases, there will just not be enough time to sell the business well.

"Suitable businesses should consider incorporation if they are not already limited companies, or transferring their shares into a trust. However, businesses should be aware that, while incorporation is easy, disincorporation is more difficult." The advantage of the last two options, he explains, is that the capital gain can be created this year, when retirement relief is still available in full, but the owner need not sell quickly or relinquish all control right away.

Tax is only one issue that a good succession plan should cover. Keeping it in the Family, a booklet produced by the Acca for family-owned businesses and their advisers, recommends starting by asking: What is the "philosophy" of the business? Must it stay as a family enterprise or is it more important to realise the maximum value from the business?

It helps a great deal to bring in the expertise and objectivity of a professional adviser, such as an accountant. The plan must be based on a sound knowledge of the business, and it should spell out, among other things, the criteria for selecting the next chief executive; how business practices, contacts and procedures are to be passed on; when the changeover will take place; and how the retiring members' aspirations will be met in future.

Conflicts over the succession plan can be resolved or prevented through setting up a "family council", a forum in which all those involved can talk over the issues in a neutral setting.

To preserve the value of the business, the plan must cover the handover of responsibility as well as the transfer of ownership. The two need not be the same.

A "one man band" business will not keep its value when the founder leaves. It is important to build up the skills, contacts and knowledge of its future managers, and to look at ways to use its brand name as an asset.

Arguably, exit planning should be done from the outset.

Mukesh Gunamal is chairman of the Association of Chartered Certified Accountants' taxation committee.