4 Steps on how to transfer the Family Business to next generations

4 Steps on how to transfer the Family Business to next generations

How to transfer the family business to next generations?

Timely and proper transferring of family assets requires careful planning and training of successors and documenting the rights and obligations of all family members. This should be based on discussions between qualifying family members in which each express their wishes, worries, objectives and ambitions regarding the family and its joint assets.

In this article 4 key steps are described which allow for a successful transfer of family owned assets to succeeding generations.

Step 1 – When to start the transfer process and who should be involved?

Experience shows that an early start with the inevitable transfer process substantially improves chances of a successful hand over to the next generation. The more involved members of the family are the better. It is essential that they take part on an equal footing and freely express their views. Some first key questions generally are: who is member of the family? Are in-laws –full- members? Are minors? And how about adopted children or those borne outside marriage? Once family- membership is agreed and clear, the next question is how to proceed and with whom?

Step 2 – Identify who wants to succeed and what training is required

Family-heads traditionally decide on their own who should succeed and when, rather than involving family members who can express their views and interests. The patriarch has the final say, but if he wants the transfer to go well and without future trouble, then advance truly open talks between family-members telling what they would want and expect, will certainly help.

For this involving an independent, experienced outsider can be the key. He should start by interviewing all eligible members. Then based on his findings he moderates discussions between family members to agree on the best successor(s). If there are more candidates then each should present their qualities and plans to the family deciding the best candidate. Thereafter a plan to train the potential successor should be adopted, while also the other members should be educated for their role as stakeholder.

But what if no one wants to succeed or has the capacity to do so? Then a non-family member will have to run the family business if it is not sold. To enable that to go well I recommend reading the articles dealing with family governance and family charters. Such documents should allow for outsiders to run the business adequately, while family members can enjoy (financial) rights and accept obligations and limitations.

These documents should also cover subsequent generations and possibilities for them to be(come) executive, and their necessary qualifications.

Step 3 – What rights and obligations should the successor and the other family members have?

Many family businesses fail after a transfer to the 2nd generation and most do not survive a transfer to the 3rd generation! This is because family businesses are generally started by entrepreneurial people who build their business on inspired plans and inspiration. At that stage there are few strict rules and limitations. Profits are applied for the business and with the business grow the experience and know-how of the creator. The founder is often convinced that his children are unable to succeed until they are quite old. A late transfer limits the chances of success!

When kids are finishing school, time has come to start the transfer process by first agreeing and laying down a clear, fair and transparent foundation for the future of the business (or other substantial joint property). Also the rights of all –agreed!- family members now and in future should be fixed, while the candidate-successor should start an intense training.

A committee of wise outsiders can both help to overview the training and protect the position of other future stakeholders as well as the business. So the process must start when the kids are relatively young. It must include discussions on and documenting of rights and obligations of all concerned allowing for a strong business that can be run without undue interference but with informed family members who receive a reasonable, pre-determined income from the joint property.

Step 4 – When should the transfer actually take place and how?

People do not live forever, but experience shows that owners of significant family assets can wait very long with handing over. Most of the time transfers take place upon the execution of a will, the contents of which are frequently a –bad- surprise to the family. Clearly earlier and pre-discussed documentation helps considerably and heads of families should not be afraid to open up on this. It is in fact their prime responsibility to ensure that both their business and his family are ready for the transfer of both the power and the legal title. Structures should be in place to separate power from the legal rights of all stakeholders (see a.o. articles on Foundations and (voting trusts).

There are ways for the older generation to make a transfer so that they can turn the wheel back if things do not work out as planned. However when that route is followed, the step to actually hand over should be taken when the younger generation can do so without undue interference from the elder, but with the possibility to benefit from their experience and knowledge. The new generation will do things differently but not necessarily badly. Also the family constitution should allow for some flexibility and adaptability.

Before the transfer takes place some organisation, committees or boards should be in place so that all members of the family are informed and have an agreed level of influence. Qualifying members of families should be on such boards probably together with 1 or more trusted outsiders who can protect all interests and help resolving potential differences of opinion by acting as mediator or arbitrator.

Fair treatment is essential

It is never easy to hand and to take over but good preparation, transparent documentation and fair treatment of all, is essential!
Most successful people find it increasingly difficult to let go and yet some day, they must! It is relatively easy if there is only 1 child, but when there are more, it is important to start the succession process soon. The successor must be identified and all concerned should be happy with the choice.

Establishing Training, Rules, Rights and Obligations

After that, the training should start while also discussing and establishing the rules, rights and obligations in the family. Such family documentation works best when it is based on broad family-wide discussions so that everyone feels contributor to what must be a fair piece. That will help the successor to run the business well while all others are getting the right information and their fair share out of the successfully transferred family business. https://www.nomoreworries.nl

Should we have a Family Constitution and what should it cover?

Should we have a Family Constitution and what should it cover?

By simply going through a good process to create documents like a Family Constitution or a Family Mission, the family is at the same time practicing good governance in a “hands-on” practical manner. 

What is a Family Constitution?

A Family Constitution is like a constitution for a country (or the By-laws for a listed company). The benefits of having a Family Constitution are:

  • Decision-making is clear. In a Family Constitution the rules are set out for exactly how decisions will be made.
  • Which kinds of decisions are made? The Family Constitution will explain which kinds of decisions will made by the Family Council; which are areas of personal decisions, for the family member to decide (such as the Bill of Rights in the United States), and which are the major decisions that need to be referred back to the larger family group for approval. (For a listed company this is like the business areas that can be addressed, and which decisions can be made by the Board itself and which are the larger decisions that need to be referred back to the shareholders/owners for approval (such as a sale or major acquisition)).

What is usually included in a Family Constitution? Each Family Constitution is very much tailored to the particular family. Some families like to begin with a simple, short Family Constitution and add to it in future Family Council meetings. Other families like to address and include every issue they have in their minds.

  • Preamble is very important. The best Family Constitutions begin with a Preamble of why the family is making the Family Constitution. This allows a family to tell its story about why it cares, what the history is, and what the long-term goals are.
  • Flexibility is very important. The Family Constitution is intended to apply to future family members and in future circumstances. It is very important to include a provision on how the Family Constitution can be amended. It must be a flexible document or it will not survive.
  • Creation and Operation of a Family Council. The Family Constitution will include the basic structure of the family decision-making process. This includes the formation and operation of the Family Council.
  • Rules for Shared Assets. If the family has shared assets, these often cause friction within the family because of the lack of clear rules about how and when they are to be shared (and who is responsible for what). These include vacation homes, family compounds, private aircraft, yachts, etc. This is a common area that comes out of the initial individual interviews. The Family Council can propose rules for use, for approval by the larger family, and these rules can be included in the Family Constitution.
  • Conditions for Employment in the Family Business. If there is a family business, another area that often causes family conflict is whether or not there are any agreed-upon rules for entering the family business. Families who decide to have clear rules often want to include them in the Family Constitution. The exact rules will depend on the particular family. Sample rules include:
    • Educational Requirements. Are there any agreed upon educational requirements? These might include having a particular type of degree, in a particular field of study, from a particular type of institution, with a particular set of successful grades, etc.
    • Outside work experience. Another common type of requirement is to be employed outside the family business prior to entering the family business. These requirements often include the number of years to be employed outside, the type of outside business, and the success/promotions displayed during that time.
    • Defined Progress System. After joining a family business, it may be helpful to spell out how important it will be for the family member to report to someone outside the family, who can monitor the progress by evaluations and also to provide mentoring.
    • Provision of Executive Coach. Another provision that can be helpful to a family member who joins the business is to provide support in the form of offering an executive coach.
    • Termination of a Family Member. This is not usually addressed, but is a very sensitive subject that could be addressed ahead of time, instead of at a time of crisis. Most families agree that it is important to the business, to the other employees, and to the family members, that the family member who works in the business be accountable for his or her performance in the same way that non-family employees are accountable. In the Family Constitution it may be sufficient to simply state that principle.
  • Family Members Serving on the Board of Directors. If there is an operating business, one area of great value for the future is to provide that one or more family members will be expected to serve on the Board of Directors. This area could include provisions for:
    • The number of family members expected to serve on the Board.
    • Their required experience (if any)
    • Their term of office (best practices would treat them the same as all other board members)
    • The possibility of creating a “Junior Board” for members of the next generation to gain experience of a Board.
    • Encouragement of at least one family member to serve on the investment committee of the Board.
    • If there are multiple businesses, to adopt a procedure of family rotation among the various Boards.
  • Dividend (and distribution) Policies. If there is a family business one issue that is always of great interest is the amount of a dividend distribution. This is an especially sensitive issue if one or more family members work in the business (and receive a salary income) and one or more family members do not work in the business (and would receive only dividend income). It is critically important that the employed family members are paid salaries that are considered fair by all family members. (The communication about the salaries is part of the “transparency” value.) It is also important that the whole family agrees that the dividend policy is a fair one.
  • Salaries for Family Members. Usually family members agree that a family member who is employed should be paid the same amount that a non-family member would be paid for the same position. That can vary by family, however. Some families agree that the employed family member, especially at the Chairman level, is expected to spend more as part of the related social obligations in that culture, and so should be paid more to cover those expenses.
  • Exit Provisions. If there is a family business, and especially if some family members are not satisfied with the amount of the dividend distributions, it may be wise to include in the Family Constitution a method for the dissatisfied family member to “exit” from his or her ownership position. In other words, the family member could sell his or her stock and receive the cash instead. In fact, some multi-generational family businesses claim that this “escape valve” has been the key to the lasting success of the business. https://www.brhauser.com
Important things to know when organising the Family Business

Important things to know when organising the Family Business

Organising the Family Business

Family reunions and family council

Transparency fosters trust. As former US Supreme Court Justice Louis D. Brandeis once noted, “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants ….”

This holds true for families as it is applicable to the sound management of large commercial companies. The place where this transparency can be achieved in families is the family reunion, a gathering of family members at regular intervals during which information is provided to the family members on the ongoing business, important events and future developments.

In particular if families are large and where the family decides to include spouses and children (of a certain age) to be admitted to the family reunion it makes sense to create from the family body a committee charged with the organization and running of the family reunions. The formation of such a committee – or family council – should be based on the family charter which should define its duties, exact composition and its decision-making powers and the requisite procedure.

In its function as the link between the business and the family, the family council has the duty to disseminate information about the business to the family members at the family reunions. The family council should draft an information policy regarding the development of the business. Holding family reunions and involving younger generations from a suitable age goes towards establishing a healthy understanding and identification of these persons with family business.

The family council is best made up of family members with a direct stake in the business or who are actively involved in the management of the business. Choosing a chairperson for the family council can be a challenging task.

The person should be someone that enjoys wide trust within the family and who has a large measure of experience in the family business and who can also communicate well with the various groups making up the family reunion. Since it is also the chairperson’s calling to promote compromise and facility consensus among the family members it is advisable not to appoint the CEO of the family business to this position. In many instances the CEO might lack the objective distance to the business necessary to achieve a healthy compromise.

Information and communication

In order to ensure positive relations within the family and the environment in which the family business operates (inner realm being the family and the outer realm being society at large), a sound and honest information policy should be devised and adhered to. Depending on the size of the family involved such communication may take the form of regular dinner table discussions or the distribution of updates in the form of family newsletters.

Both formal and informal communication should find their place. Discussing family relevant business issues at an early stage and with the necessary frankness are an important part of avoiding or diffusing differences of opinions and conflicts becoming insurmountable.

Taking into account that the perception of a family business by outsiders and the public at large has significant influence both on the reputation of the business but also on the loyalty of the family members to the business it is important to also develop a coherent and positive communication policy to the public. By communicating major decisions to the public, the family can increase its credibility and gain the trust of the general public and its customers.

At the same time the advantages of a positive communication policy need to be balanced against the need to keep confidential certain valid business interests, trade secrets and the will to safeguard the family’s privacy interests. Where no clear and well supported communication policy can be achieved internally, it is advisable to include an external chairperson or mediator in the process. https://www.prager-dreifuss.com/

These archived articles are written by authors no longer participating in the Family matters on line project. These articles may still be relevant however. If you want more information please do not hesitate to contact us and we will try to put you into contact with the original author or another expert in family matters.

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Example of a Family Covenant – Part 2 of 2

Example of a Family Covenant – Part 2 of 2

Part 2 of Example of a Family Covenant

Suggested format of a family covenant with different clauses, as may be relevant, part 2 of 2, clausues 8-16.

9. Ownership and transfer of Company shares

Review (and amend if necessary) ownership structure with regards to various share types:

Decide whether the family members that hold a management share can appoint themselves and/or anyone on their behalf to the board of directors

  • Set the value of shares held by the founders, in the event of their death or incapacity.
  • Formulate the terms and procedures to be applied in the event that a shareholder wishes to sell his shares.
  • Refer to cases in which: shares are inherited (e.g. living spouse receives same compensation as the deceased but loses management and/or decision taking right).
  • transfer of shares following divorce.
  • transfer of shares to a family member.

 10. Employment of family members

(Define who may take part in the management and control of the business and who may not, and under what conditions a family member who does not have ownership or managerial positions, can be employed by the company).

  • The parties to this covenant wish to qualify their children to work in the company and/or in its subsidiaries.
  • Every family member is allowed to work in the company for a certain period and (define period and salary).
  • (Define procedure for the acceptance of a family member for full time employment by the company, e.g., confirmation of the board of directors).
  • The salary of a family member must be confirmed by the board of directors following the recommendation of the direct superior of the said family member. The salary has to be in line with the average working wage, and will subject to the recommendation of the direct superior of the said family member.
  • Insofar as the Company shall need to employ service providers that are not in the main field of business of the Company (lawyers, accountants, computer persons etc.) preference shall be afforded to the employment of service providers from within the family, subject of course to their suitability to the position and the required service. Without derogating from that set out above, it is hereby agreed that every person from the family that shall desire to provide services to any of the Companies shall be required to present his candidacy for the provision of said services before the board of directors of the Company during the process for the selection of a service provider in which process other persons that are not members of the family are entitled to participate.

 11. Company expenses

  • As a rule, the CEO of the Company shall ensure that all of the managers of the Company shall not impose expenses that are not incurred for purposes of the business on the Company resources.
  • Matters which cannot be agreed, or that constitute an inherited conflict of interest will be decided by the board of directors.

Consider adding a general policy as to ownership of vehicles, business trips, studies and education and vacation to the Family Covenant.

12. Withdrawals from Company / subsidiaries

  • The company will keep a register of the withdrawals of each family member.
  • A shareholder that withdraws funds from the Company must report on such withdrawal to the Company bookkeeper by the end of the month in which the withdrawal took place.
  • Settlement of all withdrawals will take place once annually. (Decide whether such settlement shall include all withdrawals, withdrawals and purchases made out of Company/ies account/s and also whether such settlement includes all expenses or if living expenses, for example, are excluded).
  • The salary of each shareholder and the maximum sum of withdrawals will be decided by the board of directors annually, at the beginning of each year. (The said amounts will be decided while taking into consideration the family desires to live at a high standard of living as well as the financial situation of the Company, based on its performance in the previous year.).
  • (Set a date for an initial settlement of accounts, in which all the assets of each shareholder will be evaluated, including past withdrawals and the value of real estate and financial assets; decide when and how a shareholder can withdraw and access funds following the said settlement).

 13. Incorporation of holding companies

Consider replacing direct ownership with holding companies, one for each family; set out ownership structure and terms for transfer of ownership.

 14. Family council

Consider the constitution of a family council, include details about:

  • Council Composition.
  • Topics to be discussed at the council and/or under the council responsibility, e.g., philanthropy, family inheritance, irregular finance of a family member, family-community relations.
  • Frequency of meetings.
  • Membership in council.
  • Quorum required for decision taking
  • Representation of an absent council member.
  • Presence of non-family members in council meetings.

 15. Incorporation of family investment company/ies

Consider incorporating one investment company that will hold all family investments that are not part of the core business and that are not private assets of any of the family members:

  • Define the ownership structure and management of the investment company.
  • Decide how investments are reviewed, accepted and executed.

Amendment and updating the Covenant:

  • Define a certain time in which the covenant cannot be amended or changed.
  • Define the quorum required for accepting a proposed amendment.
  • This covenant may be amended upon the initiative of any party to the covenant, provided such change was discussed in the presence of all parties.

In witness for the acceptance of the principles described above, we convened in * and signed this Family Covenant on this * day of *(month), 201*. https://rosak-law.com/

 

____________________

Signature

Avi Abramovich

Avi Abramovich

Rosak Law

Example of a Family Covenant – part 1 of 2

Example of a Family Covenant – part 1 of 2

Example of a Family Covenant – Part 1 of 2

Suggested format of a family covenant with different clauses, as may be relevant, part 1 of 2,clauses 1-8.

1. Introduction

Explanation about the family structure, the relevant assets, the nature of the family business and the manner in which the structure is to be managed.  In most cases, family assets are divided into the core business, being an active company/ies, on the one hand, and assets held by the family for investment purposes, on the other hand. You will find below a separate reference to each.

2. Definitions

Define who is a “family member”, “founder”, “second generation”; what activity is considered to be the core business; which company/ies are part of the core business and which ones are for investment purposes; which assets are business assets and which are family assets.

3. Family values and visions; reasons for having a family covenant

What the family values, the family vision and aspirations are, examples:

  • The core business as a source of long-lasting pride and income.
  • The need to set up a principal framework for operation, also upon a change in needs.
  • The wish to keep amicable relations within the family.
  • Provide a framework for the growing family, not only for the day-to-day management but also as a means of dealing with conflicts and avoiding misunderstandings.
  • Formulate exceptions, division of roles, and decision making processes.
  • Assistance in distinction between management, ownership and family.
  • Formulate rules and norms that reflect the commitment to the expanding family as well as the community in which we live, in order to provide an appropriate foundation for economic prosperity as well as independence for the separate core families.
  • Allow common activity of the whole family, without impeding upon the independence of each member, and such member’s right to enjoy the family assets and the business profits.

4. Expectations of the future generation for the coming years

  • Find a way to keep the family business active and allow for all family members that may be interested in participating in the family activities.
  • Formulate the rights and obligations of family members that participate in the family business, and avoiding a situation in which being part of the business is taken for granted.
  • Ensure that each family member that is interested in participating in the business is committed to the business and contributes his time and energy in this respect, while accepting and applying the decisions taken with respect to the family.
  • Set out a decision making process in which the second generation takes decisions together with the founders.
  • Incorporate into the family business the personal abilities and the important contribution of each member of the second generation.
  • Formulate rules for the incorporation of the second generation into the family business.

5. Milestones following the signature of this covenant

We suggest setting precise dates or a time framework:

  • Complete transition to good corporate governance – a separation between management and board of directors.
  • Promote business plan with regards to the required organizational structure of new business.
  • Decide what is the required organizational structure for the various business fields.
  • Set principles for the transfer of ownership between the generations 1.

6. Safeguarding the economic security of the extended family

Consider the creation of a family fund to finance various matters; discuss the way such fund will be managed:

  • The family will try to keep the balance between business and family issues.
  • The legal structure and the division between the family assets and the business will be determined according to economic profitability.
  • Business matters are to be discussed at the board of directors and/or at management level; family matters will be discussed at the family council (see section 14 in part 2).
  • Business discussions are confidential, unless agreed otherwise.

7. Structuring the family assets

Review the family assets, divided into core business and investments, provide details on the core business and the ownership structure; set rules for future classification of assets, ownership structure.

8. Core business

Set rules about the ownership and management of the core business:

  • The family will act, through its lawyers, accountants and counsels, to adapt the legal structure and the various company documentation to the rules set out in this covenant.

https://www.rosak-law.com

Avi Abramovich

Avi Abramovich

Rosak Law
  1. from the founders to the second generation, and from the second generation to their heirs[]