STEP New York 11 June 2015

Planning for Closely Held Businesses II How to Build a 100 Year Enterprise

Johannes Burger

Marxer & Partners, Vaduz and

John Riches RMW Law, London

Introduction

• Natural instinct of business founders to see their business endure to benefit future generations

• Many forces are there to cause family businesses and wealth to fragment over two to three generations Family conflict

• Siblings and cousins • Marital breakdown

Subdivision of wealth amongst a growing number of bloodline heirs

Taxes There may be no heirs!

• Is the goal therefore one which is realistically achievable or desirable ?

• Perspective of two European lawyers who have each worked with business families for more than thirty (30) years

• Experience drawn from working with families from all parts of the globe

• Starting point is that legal advice is only part of the toolkit that business families need to achieve their goals

• Plan to examine the topic through practical examples around some key principles

Context of Remarks

• Preserving the Family Business - United We Stand or Divided We Stand?

• Individual vs Collective Ownership - When to Employ and Why

• Equality Between Family Members - What is Equality? • Building Workable and Adaptable Governance

Structures • What Happens if Bloodline Does Not Survive?

Key Principles/Phrases

• Natural inclination of founder is to try and create model that assumes future generations should continue to hold the business in common

• On that basis, ‘United We Stand’ is the appropriate motto Articulating a shared vision and purpose for the family’s role as

business owners is essential Building a sense of family identity and values that are reflected in the

way the business is conducted will allow strategic decisions to be made with a clearly articulated long term goal

• But compelling future generations to stay together as common owners/managers may have the opposite effect – if there is a sense of ‘Hotel California’, individuals and family branches who feel bound together in perpetuity will revolt and push for an exit

Preserving the Family Business – United We Stand or Divided We Stand? 1

• ‘Divided we stand’ is a counter-intuitive motto Might be seen as the antithesis of the mind set and philosophy required to

allow the business to remain in family ownership Emphasis on generational autonomy- each generation has a fundamental

choice about whether to remain as business owners Fact each generation is not ‘locked in’ means there is a sense of

empowerment and personal autonomy about remaining in the business Family leaders cannot take loyalty of family as a given - this dictates the need

to build healthy governance so that all voices are heard Does not mean that family members are permitted to exit in an unstructured

way: • can be combined with family ‘recommitment’ to remain invested for minimum periods

every five/ten years • exit policy can provide for substantial discount and delay to avoid upsetting long term

investment plans Wise to allow family autonomy over non-business interests

• Evolution of separate family offices to oversee private interests is healthy and desirable

Exit from business does not mean exit from family

Preserving the Family Business – United We Stand or Divided We Stand? 2

• Merits of individual ownership Personal autonomy/sense of responsibility Simplicity

• Can be combined with a sense of stewardship and collective ownership

• Value of business a key issue • Some interesting long term models require owners to

transfer at nominal value Hoare family – own oldest Bank in United Kingdom formed in 1672 ‘Partner’ concept with unlimited liability of individuals Philanthropic values First non-family Chief Executive Officer appointed in 2010 Partners on retirement can only realise a nominal value for their interest

Individual vs. Collective Ownership – When to Employ and Why 1

• Merits of collective ownership Typically common law trust or civil law foundation

• Helps to keep a united family voice as business owner • Promotes inclusive governance that requires decision

makers to take a multi-generational perspective Limits scope for ‘black sheep’ to disrupt long term plans

• Can achieve better fiscal outcome In some cases, possible to secure long term exemption from estate taxes

• Better asset protection (divorce/personal insolvency) Not reliant upon family members entering into pre-nuptial agreements As no family member owns a fixed percentage interest, harder for creditors to

attack

Individual vs. Collective Ownership – When to Employ and Why 2

• Collective ownership more flexible if founder with hybrid objectives allowing family interests to be balanced with other goals Possible to design purposes for preservation of the business

• to benefit employees • to achieve a social or philanthropic purpose

• Designing governance model is critical Some individual or group must have final say

• ‘Quis custodes ipsos custodes?’ Family may be given ultimate say through choosing decision makers Committee based structures with special majorities for key decisions may be

included

Individual vs. Collective Ownership – When to Employ and Why 3

• Deep sense of what is fair pervades any common view of what principles should be given inheritance of wealth Fairness does not always mean absolute equality Some inheritance systems rely on primogeniture or favour mail heirs to

preserve family name/avoid fragmentation

• In considering division of business in economic terms, most founders adopt a ‘per stirpes’ model based on their children as equal branches This means the third and subsequent generations may inherit dramatically

different interests Example: Three children have respectively 1, 2 and 4 children. By the third

generation, between cousins, the only child has a stake in business that is four times larger than some of his peers .

Equality Between Family Members – What is Equality?

• Creation of split economic and governing shares allows for fairness in economic interests whilst providing for the selection of family leaders who have greater influence over business decisions

• This model carries risks in creating divided and potentially opposing interests of working and non-working family members

• Governance is the key to continued ‘legitimacy’ of family decision makers, especially in third and subsequent generations Checks and balances are critical here Proper reward for family members who give their time In some cases, family may cease to be employees – at this point, aligned

desire for whole family in ensuring accountability of managers to family as owners

Equality Between Family Members

• Assumption that the family will endure should be challenged in designing the inheritance model

• Gives rise to key questions as to who is included within ‘family’ concept

• Model with strict reliance on bloodline heirs born to married couples preserves purity of family ownership

• Most families are open to an enlarged concept of family that includes Adopted issue Illegitimate issue

• More controversial is potential inclusion of Spouses Step-children

• Wider family group can have valuable talent and enhance chances of preservation of business

What Happens If Bloodline Does Not Survive?

• Business should be there for the family not vice versa 100 year goal is only valid if it serves family needs In some cases, it may be better to set a less ambitious target of transition to

the next generation

• Challenge is to build adaptive ownership and governance models to meet changing circumstances

• Open minded approach on structure is helpful • Giving family autonomy and independence in other areas

important • Important to ensure family’s engagement with business is

preserved • Exiting the business does not mean exiting the family

Conclusion