This article examines the importance of succession planning for family businesses at a time of constant change in regulatory and tax.

Editor’s note: The following article giving succession planning advice comes from Marc Farror, who is the private client and family office director of Vistra Jersey.

Like all businesses, family businesses need to deal with a diverse range of challenges which typically include reacting to market turmoil, cash flow pressures, retaining the best management talent and driving international growth. Without doubt, though, the most critical challenge involves generational change.

Within the trust world there are countless stories of families who create wealth through an entrepreneurial individual and lose it again within three generations. Often the wealth creators can directly influence the second generation, their children, to be frugal. However, whilst the children may be careful, they may not always be as expert at creating wealth as their parent. Very often, the children will manage to maintain the status quo, and keep the family wealth static. However, given inflation and the increasing cost of living every year, maintaining the status quo can often mean that the family are gently eroding their wealth in real terms.

When grandchildren arrive, they may be born into wealth and may not always have the same discipline that was instilled into their parents. If few family controls are in place, this can sow the seeds of disaster, as some might feel it is acceptable to go on to spend the family fortune with largesse. Under these circumstances, it really is only a matter of time before the majority of the wealth is eroded.

Making a success of succession is not by any means impossible and there are large numbers of high profile families who not only protect their family wealth, but manage to actively grow it from one generation to the next. So the question is, what distinguishes the family who diminish their wealth from the family who actively manage to grow their asset base and how can the trust industry contribute to the key area of succession planning?

Effective family decision-making

Family governance is a well understood concept within larger families. Many trustees work closely with families and their advisors to ensure a detailed and recorded family governance process in place and implemented by all the family, as its importance is recognised when planning the protection of wealth beyond the second generation. Where good governance is created for families covering the manner in which they operate their businesses, it can impose similar disciplines as are seen under the statutory corporate governance required for a PLC.

Governance helps determine how, when and by whom decisions are to be made. It helps resolve disputes within the family and also how to resolve differences between the family and the trustee, all of which can impact upon the preservation and growth of the wealth.

Good governance, then, lies at the heart of effective succession planning and it is an integral part of wealth structuring.

Education is an investment in the future

The education of family members should not be limited to the process of formal education through school and university. Rather, business-oriented families need to establish their own values and be clear about what those values are, if they are to be handed down. Whilst today it might sound odd to try to codify such ideas, for the entrepreneur thinking ahead to future generations, it can be useful to see basic principles written down in the context of the running of the family business. Typically these might include:

Establishing codes of behaviour regarding how family members talk and inter-relate to each other. An environment needs to be created where family members feel free to express their opinions frankly, thereby avoiding divisive and ultimately destructive conduct.

A similar open forum needs to be developed about how family members can both earn and spend money. In the more successful family dynasties there is a direct correlation between effort (in the family business) and reward.

Establishing a process for looking after all family members, especially those incapable of looking after themselves such as children or aged family members.

Dispute resolution

Establishing rules about what education and experience is useful for family members to bring to bear on the family business. For instance, many families who run their own family office like family members to have worked for a significant period in, for example, the investment industry prior to entering the family business.

Developing an approach to philanthropy. Whilst it is not essential that families give to charitable causes, philanthropy certainly is a proven way of engaging family members who are not core in the family business, and providing a worthwhile outlet for their energies. Philanthropy also has the added advantage of improving the profile of the family.

Secrets can cause problems

Whilst establishing open channels of communication within the family can help eliminate divisive behaviour, the same can certainly be said to be true of communication between trustees and individual beneficiaries. One of the perennial problems that trustees face is how much information they should pass to beneficiaries.

Two cases highlight some of the issues that trustees face regarding the flow of information.

In the Rabaiotti Settlement (1989) it was established that the beneficiaries of a trust could inspect the trust accounts providing it is in the best interests of all the beneficiaries. In addition, a letter of wishes could be disclosed to the beneficiaries if the court felt that there was good reason to do so.

In Schmidt v Rosewood (2003) the case recognised that there is really very little difference between being a beneficiary of a trust and being a mere object of a dispositive power when it comes to being given trust information by the trustee. Providing the object of the power has a genuine and legitimate expectation of benefiting under the trust, no distinction should be made between beneficiaries under discretionary trusts and objects of discretionary fiduciary powers when it comes to the disclosure of information.

On a practical basis it perhaps makes sense for trustees to engage with beneficiaries as early as possible. This allows the younger beneficiary to understand over a period of time why and how decisions are made. In addition, they can develop a better comprehension of how investments work and what the family’s investment strategy is. Generally, this dialogue builds a greater appreciation of the role that the trustee actually plays on their behalf.

Where beneficiaries are suddenly exposed to trustees, having had a lifetime of isolation, the trustee often faces a much harder task in explaining their role and accounting for their decision-making. Very often the settlor’s best intentions of protecting the beneficiaries are seen as manipulative and the trustee is often the one held to blame.

In such circumstances, the choice of trustee and an agreed communication protocol are critical, as it can be a fine line between a settlor’s intentions and the best interests of a beneficiary.

Using appropriate structures

With changing tax laws, an evolving beneficial class, and greater fluidity around where beneficiaries live and what taxes they become subject to, it is often easy for a structure to become obsolete. The ongoing assessment and resulting adaptation of the structure can very often help maintain tax viability, provide control over the current trust assets and actually build a better relationship between beneficiaries and the trustee. By way of example, the following structures could be implemented to ensure that change is planned and effective:

Trusts - Whilst it is common for a close family friend or a non-beneficiary family member to be appointed to steer the trustees in the best interests of the beneficiaries, the notion of a professional corporate protector is gaining increasing recognition for the improved unity it brings to relationships between trustees and multi-generation jurisdictional beneficiaries.

Foundations – These can offer greater flexibility whereby family members can make up the majority of the council members. The foundation’s council is the body that administers the foundation’s assets. In Jersey, foundations are required to have an enforcer role, which is akin to that of a protector, and that too can be occupied either by a family friend, family member or professional corporate enforcer. The guardian’s role is to ensure that the council carries out its functions in relation to the charter and the beneficiaries.

Private Trust Companies – have been established in offshore jurisdictions to provide families with the ultimate level of control, and the family can provide the majority of the board of directors required to run the trusts underlying the Private Trust Company, alongside advisors and fiduciaries.

Shariah structures – for Muslim families, having a structure that is Shariah compliant is essential. Many families from the Middle East use a combination of Waqfs and Shariah-compliant trusts that their family’s scholar approves. Waqfs and trusts have many similarities and many academics consider the Waqf to be the precursor to the trust.

Accommodating a limited aptitude or inclination for the family business

When it comes to succession planning, having a neat, well-spaced line of educated and enthusiastic family members would be perfect for planning how the family business is to be taken forward. However, given that families seldom work out in such an efficient manner, a formal process is needed to cover for eventual gaps in the succession planning. In addition, family members who have no aptitude or inclination for the family business need to be taken account of.

Having a gap in the family succession is relatively easy to fill by appointing external professionals to run the business. In the event that family members can’t agree on who the best external candidate to run the business might be, it is often left for the guardian or protector to have the casting vote and make the ultimate decision about who is most suitable. The guardian or protector will need to take a fiduciary position in this process and make a decision that they consider to be in the best interests of all beneficiaries.

Where there is no inclination for family members to become involved in the family business, conflict can often arise. In some family structures it can be normal to reward family members who work in the family business more favourably. Alternatively, it is also common to recognise the value that family members make by undertaking highly productive but lowly paid work and compensate them with extra funds to recognise the wider contribution that they are making to society.

Family members who have no aptitude for the family business represent a slightly larger problem. However, if a family member has their own business ideas, these can be supported by the trustee provided the ideas are well thought through and the trust deed allows it.

If the family member chooses to have no employment at all, philanthropy can provide a positive outlet for these individuals. This is particularly true where philanthropic decisions must be made regarding which charitable sectors the family wishes to support and those charities within the sector that represent a reasonable investment. Naturally, ensuring family members conduct their own due diligence regarding the day-to-day operation of a charity, how they help at a grass roots level, and how effectively the money is spent are essential exercises in themselves that can be overlooked, unless a process is established.

Investments and commercial initiatives

Ultimately, to keep increasing a family’s assets, a degree of investment risk must be taken to ensure that the family gets a return from its assets that beats inflation. The current volatile state of markets illustrates just how hard this can be in practice.

An investment strategy reflecting the family’s appetite for risk is needed which is acceptable to all beneficiaries and which allows for a financial performance that grows the asset base in real terms.

The process can also be structured to allow trustees to consider other asset classes such as property and alternatives, alongside traditional funds and equities. Whilst some of these assets and investments may have a higher risk profile, that risk can be managed by the trustee within the context of the rules of the structure chosen.

Making a success of succession

Planning, education in its broadest sense and the use of appropriate structures and investment strategies can all be combined to create an environment to enable a family to prosper and both keep and create wealth, but care and attention to detail are essential, if the family is to flourish. Good governance both within the family and between the family and trustees lies at the core of an effective succession strategy.