According to the Institute for Family Business (IFB), in 2020 there were 901,000 micro family firms in Greater London. Most of these are unlikely to have sufficient legal protection in place to help ensure their long term success and maintain the owners’ financial interests. As unincorporated businesses operating as partnerships, they are likely to be at risk from factors that a partnership agreement would otherwise regulate.
Such small family businesses need to implement a robust legal structure to ensure their smooth operation and running. Additionally, they need to plan carefully for the succession of the business so that it can be passed on to future generations.
Legal structures of family-owned businesses
The IFB report finds that nearly 80 per cent of family-owned businesses in the UK are micro-businesses with no employees. For example, they might be a husband and wife working together, or a father working with a daughter who aspires to take on the family business. Owners of such small to medium sized firms (SMEs) are unlikely to have the resources to assess which type of legal structure is most appropriate given the business’ goals.
Without such consideration, family business owners are more likely to be operating under informal partnerships where their relationship as business partners and the major affairs of the business are regulated by a set of default rules in the Partnership Act 1890.
Lack of scope for current business practices
The Partnership Act, being severely outdated, poses huge problems for the smooth running of any business in light of modern business practices. It can also prove to be disastrous for the continuity and longevity of the business.
For instance, if you are running a convenience store with your spouse under an informal partnership, the business will have to be dissolved if either of you wants to leave it.
Other issues with the Act are:
Under the default rules, partners share equally the profits and losses of the business. This may not be appropriate in all family businesses where some people will take a different share of profits.
Control & management
The Act assumes that all partners are equals in terms of control and management of the partnership. All matters concerning the business require a decision on the basis of the majority. This may cause disputes within the business as younger, less experienced family members join the business with just as much power as senior members.
In an informal partnership, the arrangement can be terminated simply by one partner giving reasonable notice to the other. Further, the death of the partner would also result in the dissolution of the partnership. The Act does not contemplate a succession plan which is crucial to family businesses.
Under the Act, all partners share responsibility and liabilities of the partnership. Further, the partners assume unlimited liability for their own action. They can also be personally liable for the actions and decision of other partners.
Dispute resolution process
Without a formal partnership arrangement in place, there will be no clear and defined process for resolving disputes. Further, it is common for family disputes to spill over into the business causes issues in both quarters.
What is the solution?
The only solution is to adopt a legal structure suitable to the business objectives and appropriate to the family dynamics. This business structure should not only improve on the default rules of the Partnership Act. It needs to be thorough, covering all important aspects of how the business will be run.
Such matters include:
- remuneration: pay, profit and loss sharing and ownership of the business
- recognition of assets brought in by partners
- duration of the partnership and termination
- management and partners’ authority
- circumstances for removal of a partner
Succession planning of family businesses
Family businesses are different from normal businesses since roles often overlap and relationships can be complex. Each owner may have a different view of the firm’s future, which may affect the business in terms of ownership and management.
“One of the greatest challenges to family businesses”
The IBF reports an alarming number of family businesses in the United Kingdom have no succession plan even though the family successors are already involved. Succession plans are often only made up where succession was considered imminent or in cases where the business had grown so fast that an explicit succession plan was required. Otherwise, many family businesses do not pay any heed to this area.
Succession in a family business often depends on the complicated and unique interplay of business objectives and family politics. However, the IBR report shows that when more than one generation is involved in the business and succession plan, it makes the process all the more difficult to resolve.
Further, the UK Government’s Small Business Survey (2019) shows that only 2 out of 5 family-owned businesses are actually passed down a generation. Only one in twenty family-run businesses are at their third generation of ownership.
The need of the time is to ensure that there is a clear succession process in place so that the business does not suffer during the transitional period.
How to plan for business succession?
A prominent obstacle in this process is the challenge of actually bringing up and discussing succession planning despite its apparent need. The older owners sometimes are unaware of this or deliberately ignoring the issue.
Communicate with the successors
So what you first need to do is create a safe space to communicate. Otherwise, in the long run, the business may become strained due to the feud between the family members and possible legal actions that might ensue.
A common misconception with succession planning is that it is often confused with giving up the business altogether. Whereas ownership and management are two different things that do not have to occur simultaneously. You can still retain control over the business until your successors are ready and everyone is agreed as to the plan.
Important questions you need to answer
Succession planning is a process and it involves engaging the younger generation and any employees. You have to also ask yourself some challenging questions, including:
- Should you bring the next generation into the business if they are interested?
- What kind of skills will the successors need to succeed as responsible owners?
- What are the requirements for them to join the business?
- If the next generation is not ready or willing, who will manage the business?
- Which kind of structure will the business need when it comes to management and ownership transition?
- How will ownership of the business be shared by the next generation?
- If the future generation is unwilling to take over, do you wish to sell up and move on?
Sorting out such important matters well in time will reduce, if not completely eliminate, the chances of the family succession feuds and legal issues tearing apart the business. Incorporating them into a legal partnership agreement then becomes relatively simple.