Smooth Succession: Legal Frameworks For Family Business Continuity

The issue of succession for a family business is bound up in a complex combination of commercial and personal issues.

In business terms, the aim will be to hand the business on to people with the skills and experience needed to protect the legacy of the business and build on the current levels of success.

On a personal note, the owners of a family business will wish, as far as possible, to pass the business on to the next generation, giving their successors the chance to enjoy the same opportunities they did and build a dynasty for the future.

There are some technical legal issues around company law which might impact on this intention, however, and in this article, we’ll examine some of those issues and offer advice on how best to achieve a smooth succession.

Articles of Association

Shares in a family business are treated like any other shares – as private property which the owner can treat as they wish to, without there being any obligation to buy and sell those shares to either individuals or the company.

There are contractual, statutory and regulatory issues which complicate this, however, and the articles of association of the business are most likely to have an impact.

The articles of association set out the purpose of a business and outline the regulations which will govern operations. Points set out in the articles of association usually include the following:

• The organisation and structure of the company

• The process of holding shareholder meetings

• How shares and dividends in the company will be issued and the voting rights enjoyed by shareholders

• How directors will be appointed and the responsibilities they will have

The articles of association operate as a form of contract between the company and the shareholders, and a framework for governance of the company. Once drawn up, the articles – which will include the legal name of the company – can be accessed as a public record and are often held at the registered office of the company.

The articles can be revised, particularly if this becomes necessary due to a change in the law or because a regulatory authority has demanded the change.

Changing the articles in this manner would require a meeting with shareholders at which a resolution is passed. As well as offering a form of ‘user guide’ for the company as a whole, articles of association are often required when opening a company bank account or applying for business loans. Once in place, the articles act as a binding agreement between the company and its shareholders, and the type of change mentioned above can only be made via a special resolution which requires the agreement of at least 75% of shareholders.

Transfer of Shares

It is possible to gain more insight into how articles of association are drawn up by looking at model articles for private companies listed by shares, as published by the government. Of most relevance to the issue of succession is Model Article 26, which states that ‘The directors may refuse to register the transfer of a share, and if they do so, the instrument of transfer must be returned to the transferee with the notice of refusal unless they suspect that the proposed transfer may be fraudulent.’

This could cause issues with succession following a death unless the circumstances are covered by the Will of the deceased or a shareholders agreement which may be in place. The possibility, for example, is that the remaining board members, following a death, may disapprove of the beneficiaries to whom shares have been passed (perhaps because said beneficiaries have no interest in the company) and will therefore decline to register the transfer of shares unless it is being made to someone with whom they approve.

Many shareholders agreements will contain clauses which require an individual shareholder to offer their shares for sale to other shareholders in circumstances such as their death, incapacity or – as an employee shareholder – upon leaving the company.

If the other shareholders opt not to exercise their right to buy then share transfers will need to be approved by the board (as set out in Model Article 26), whereas if shareholders do choose to buy the shares the estate of the deceased will receive the value of the shares, rather than the shares themselves.

A method for valuing the shares will generally be included in the shareholders’ agreement, making it simpler for the executors of any Will to value an estate including shares before a sale or transfer has gone through.

There is a chance that a shareholders agreement won’t include a clause requiring shares to be offered for sale following the death of a shareholder, but even in these circumstances pre-emption rights may apply.

Pre-emption rights on transfer of shares mean that the personal representatives of the deceased will first be expected to offer the shares for sale to other shareholders before simply transferring them to the beneficiaries in line with either the Will or the rules of intestacy.

Shareholder Agreements

Everything set out above helps to underline why anyone wishing a smooth succession – i.e. leaving their shares to future generations of the family – needs to take positive action to ensure that this happens, with particular regard to the wording of any shareholders agreement. The agreement should be drafted to ensure the following:

• There are no clauses obliging shareholders to sell their shares on death or on leaving employment

• Transfers of shares to family members such as children and grandchildren are treated as permitted transfers i.e. free from pre-emption rights

• Any transfers of this kind which are carried out properly should be approved by the board

In some cases a more cast-iron clause could be inserted into the shareholders agreement, stating, for example, that only direct descendants of the named founder of the company are entitled to hold shares, and that the board does not have the right to approve transfers to any party not qualifying in this manner.

Of course, the fact that a shareholders agreement can be changed with the approval of all parties or a specified percentage of the holders of voting shares, and articles of association amended through a 75% majority, means that there is always a chance, in any private limited company, that the provisions in a shareholders agreement are not set in stone.

The commercial interests of the company will always trump family ties in the eyes of shareholders, sometimes even those shareholders with family ties, and so things could change at some point in the future.

The overarching advice for anyone planning the succession of a family business on their death is that simply passing shares on in a Will is not be sufficient to guarantee a smooth succession without paying proper attention to what is set out in the articles of association and any shareholders agreement.

It is probably true to say, therefore, that any succession planning, rather than being left until such time as that succession can be said to be looming on the horizon, needs to be at the forefront of your thinking from the very beginning, i.e. when the company is incorporated or if not at the earliest opportunity.

Should you require any advice or support on how best to preserve the legacy of your family business, please contact the specialist family business team at Buckles for a confidential, impartial consultation.