Opinion | How succession planning can create legacies for family-owned businesses

LiveMint 26 Feb 2020, 08:30 PM IST

Family Business | Personal Finance

According to a report released by Credit Suisse, an investment bank and financial services company, in the second half of calendar year 2018, India was home to the third-largest number of family-owned businesses in the world. The report estimated that a total of 111 companies with a total market capitalization of $839 billion were family-owned business enterprises. In the global ranking order for family-owned businesses, India was positioned third behind Germany and China.

The shareholding pattern of a majority of listed Indian firms has promoters holding a controlling stake in family-held businesses. These business entities are typically characterized by an overlap between management and ownership control wherein family members or distant relatives from extended families occupy prime managerial positions.

In an environment where business ownership structures are tightly managed and controlled by families, the importance of succession planning cannot be overemphasized. Needless to say, succession planning should be entrenched in the functional DNA of family-owned business enterprises. However, it’s still not an area of focus for a lot of family businesses. They simply underestimate the importance of succession planning and its role in the creation of a multi-generational business structure and ensuring the sustainability of family legacies. Succession planning helps in articulating what steps need to be followed in case of unforeseen contingencies such as illness, regulatory hurdles, accidents and deaths.

A well-conceived succession plan acts as a blueprint for ensuring asset preservation and growth. By facilitating the smooth transfer of power and control of business from one set of promoter to the successor and also of the wealth from one generation to another, succession planning can also help in avoiding long-drawn court litigations and mitigating familial discords. Though human life is finite, a carefully drafted and documented succession plan can ensure (i) the day-to-day running of businesses and their management (ii) the efficacious allocation of assets and wealth for passing down to future generations. It can also from the key part of an asset protection strategy and prevent creditors from making undue claims on the family’s wealth.

The aim of any effective succession plan should be adherence to regulatory compliance and fulfilling family goals and objectives. A family trust can facilitate wealth protection and ensure that succession planning is a seamlessly managed process for family businesses. As Wills are subject to prolonged litigations in courts of law, trusts are emerging as a viable mode for transfer of asset ownership by the owners in their lifetime. A trust mechanism ensures that businesses are passed on smoothly to intended beneficiaries without legal problem. With no single family member vested with the right to sell their individual share, a trust acts as a bulwark in preventing hostile takeovers and warding off unwarranted control bids from business rivals.

Assets transferred into a trust intended solely for relatives are fully exempt from tax under the income tax laws in India. At times there are challenges around the transfer of immovable assets which may attract stamp duty on such transfers as per applicable rates varying from state to state.

The lack of a drafted framework can act as an impediment for the smooth transfer of wealth and property for family businesses. A well-defined succession policy is critical for smoothening the appointment process of the next chairman, managing director or chief executive officer of the business. The next-in-command of the business can be from the family or from a professional background but each business house should introspect how this can be addressed. There are domestic and global experiences as to how businesses failed because of the lack of a competent CEO.

A family constitution in the form of a coded rulebook creates the groundwork for inter-personal relations, division of assets, allocation of funds, management of trusts and special purpose vehicles required by families depending upon their situation and needs. It also addresses issues like succession, business governance and conflict resolution. It also acts as a communication tool for making succession planning a participatory activity among family members and helps foster harmony and cooperation.