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Succession planning

Course: Succession planning | Last Updates: 7th October 2015

 
Matt Lobley
Centre for Rural Policy Research, University of Exeter
Biography >>
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The distinction between business succession planning and estate planning should be recognised. The first transfers management of the business, the second involves transfer of the assets.

A key decision to be made is who will be involved in management and who will have a share of the ownership of business assets.

Family history, ambition and expectation are likely to complicate both of these processes, making open and honest communication crucial to a successful outcome.

For a succession plan to maintain business growth and secure family relationships, it should aim to fulfil the family’s values and meet its objectives.

All individuals affected by the succession should be involved in the process of discovering those values and establishing the objectives. This may be a tall order for some families, but it is essential so that misunderstandings are avoided. Participants should feel free to voice their opinions without fear of reprisal or judgement.

The first step in succession planning is to examine the current state of the business to see whether there are measures which should be taken to put it in better shape before longer term plans are formed.

US attorney and adviser John Baker has worked on farming family succession in many countries for 25 years and suggests a 15 to 20-year succession plan, beginning when successors are aged 20 to 28 and seeing the retiring generation stepping down in its 60s.

He also recommends that the older generation should take the lead in initiating discussion and while those discussions should be long term, they should not be so protracted that no decision is ever reached.

Even where it is obvious who will succeed, that person’s skills, education and knowledge must be assessed to identify any gaps, rather than relying on having grown up on the farm and in the business as succession qualifications.

Mr Baker’s advice for successful succession planning includes seriously questioning the tendency for parents to want to treat their children equally. Equal is not the same as fair, he points out and splitting business assets can overburden those running the business.

Successors take over management, heirs take on ownership of assets. However, every business and family will vary in size and complexity; successors and heirs can be the same people but not necessarily.

In larger businesses, non-succeeding heirs could have shares in the business that can only be sold to other family shareholders. Such shares would have a capital value but needn’t involve annual dividends.  

Tax, legal and structural issues

While tax should not be the main driver, there are some important tax considerations in succession planning, which also have legal implications.

Too many farming families act without consulting advisers only to find that a simple action already taken for practical reasons, such as renting out a house or moving from the main farmhouse, has big tax or legal implications later on.

Often the picture is confusing with regard to which assets are owned by individuals and which by the business. So, ownership should be clearly established and then reviewed to see whether assets should be held differently for a better tax outcome.

Following on from this, wills, partnership and shareholder agreements must be relevant, up to date and reviewed regularly. Old, out of date or poorly drafted documents can be just as problematic as no will or agreement at all.

Issues such as the retirement of partners, illness, death, bankruptcy, mental incapacity and dispute resolution need to be addressed.

Flexible business structures such as partnerships, contract farming and more recently joint ventures for labour and machinery mean that are many options in terms of how to trade and farm.

Partnerships offer the most flexible trading structure for most family farms, allowing shares and reward to be changed by agreement between partners. A new partner can be introduced without assets having to be transferred at the same time, allowing a gradual approach to be taken.

The issue of fairness with regard to those who will not be directly involved in the business is often a difficult one. However, there are options such as using the proceeds of life insurance to transfer cash to beneficiaries at a later stage, along with carefully crafted wills and partnership agreements.

Discretionary trusts can also be used to allow someone to farm for life at the same time as protecting the asset for up to 120 years.

For those who own their farms, succession plans should also consider what should follow if the farm is sold after being handed on. Plans can be drawn for a division of the proceeds which reflects both the wishes of those handing on the asset and the contribution made by those actually farming.

With farmland qualifying for 100% Agricultural Property Relief (APR) from Inheritance Tax (IHT), there is little tax encouragement to pass on assets while the giver is still alive.  

Passing on qualifying assets on death usually also has a Capital Gains Tax (CGT) advantage compared with moving the same asset during lifetime, especially if land or buildings were to be sold in the near future.  

Tenancy succession also needs careful consideration and timing. Landlords may seek to introduce new terms and in some cases the value of a tenancy can help with retirement planning or restructuring.

Conflict management

Dealing with conflict will probably be a part of the journey for most families and entrenched positions will become more so unless a way of dealing with conflict is found.

This often means stepping back and looking at things more broadly, understanding people the motivation of different individuals and the pressures they are under.

While professionals may advise different parts of the family or individuals, it can be very helpful to use a third party to facilitate meetings, helping to move the process along.

Retirement

With succession comes retirement too and the recognition that roles must change, so a clear path must be planned through several stages of succession (see below).

Retirement planning is much more flexible than in the past – contract farming, other joint ventures and letting mean retiring physically and financially can be done at different times.

Also, new pension rules mean that instead of buying an annuity to provide an annual pension, income can be drawn down as cash from a pension fund year after year.

Pension planning can also include investing in the business – land and buildings qualify as investments for Self-Invested Pension Plans and Self Administered Pension Plans which give up to 40% tax relief on pension investment. Often these arrangements see the pension fund assets rented back to the farm business.

As well as considering how to provide retirement income and housing without burdening the business, issues such as nursing or care costs should be addressed.

Advice for successors

Dealing with succession planning as the incoming generation is not easy, you will have countless questions, concerns and worries, says Michael Mack, a consultant with Smiths Gore and whose Nuffield Scholarship studied the next generation of farmers.

“This is one of the biggest decisions of your life. The weight of expectation for the next generation is immense, it is important to be prepared and to play a positive role throughout the succession process.

“Becoming a farmer is a process, the three things you will have to master are the ability to produce things, the ability to sell things and the ability to manage the process and assets. The first stage in being taken seriously as a successor is to be prepared and show interest.”

Ask yourself where your weaknesses are going to be and start to address them:

  • What enterprises do you think will be on the farm in 10 years? Do you understand the marketplace that these enterprises work in? Spend time making sure you understand these markets
  • How important are people to the business, customers, suppliers, advisers? Make sure you have strong relationships with these people
  • What policy changes are around the corner? Make sure you are well briefed on these issues and open discussion on how they may affect the business
  • Do you understand what skills you will need in the future? Look at all the different roles you will need to do, work out how you will improve your skills in each of these areas. Focus first on those with which you are most uncomfortable.

    When the succession planning process starts you will have times when you feel frustrated with the speed of the process and at times your role in the decision making.  

    To maximise your influence in the succession process:

  • Be prepared:, this is about what you want to achieve, think about what others will want, what will others want from the process and how do your aims fit with others in the business
  • If you don’t agree with a decision make sure your opinion is heard and if you are unhappy with a decision make sure everyone understand your view point but don’t dwell on it and create argument
  • Follow up on all actions you are assigned
  • Ask a farmer you respect to mentor you through the process. Choose someone you trust and whose experience in farming will help you to see things from a clear viewpoint
  • Be patient.

Succession checklist

  • Where is the business now – what shape is it in, can it cope with succession?
  • Develop open, inclusive communication between all involved
  • Allow everyone involved to identify what they personally value and how they see the future
  • Discussions should be open and transparent – everyone affected should be present at meetings
  • All topics of discussion should be known by all before meetings
  • Everyone must feel free to voice an opinion without fear of reprisal or judgment
  • Everyone should be respected and should show respect  
  • Consider engaging a facilitator to help the process along
  • Are there willing successors and are they capable – do they need further education/training
  • Think broadly – there are often more options than the family thinks but the shorter the timescale, the fewer these are likely to be
  • Equal and fair are not the same – be wary of saddling those farming with obligations to other family members; this can put a strain on the business and create a pattern of falling equity and rising debt
  • As well as addressing the big structural questions, a good plan needs to consider practical issues such as housing, working hours and wages
  • Other contributions to the business or to family should be compensated – for example, the value of care for older family members
  • Always consider more than one option and list the positive and the negative consequences of each
  • Allow plenty of time for discussions and ideas to formulate – do not be rushed into making a decision but avoid a delay so long that no decision is made
  • Once a decision is made, act forcefully and promptly to carry it out
  • Build in regular review points to chart progress
  • Back up decisions with clear written agreements and documentation
  • Make wills
  • Responsibility must be transferred and there must be an end date – the older generation must withdraw
  • Tax is important but should not drive the succession plan

Key stages in transferring business management – John Baker

Planning

  • Create a plan which fulfils objectives of parties involved
  • A business succession plan involves moving management, assets, intangibles (for example knowledge of the farm and its practices, landlord and tenant relationship), labour and income
  • Plan should include a timescale, allowing for testing, commitment, new structure to be established and for withdrawal of older generation
  • Drawing up the plan can take up to a year but must be time limited and managed by principal farmer


    Commitment

  • Period when next generation moves back to business and/or takes on roles and responsibility they need to develop to take on more management roles
  • Use this period to test relationship, build commitment and develop skills
  • Current generation maintains full management responsibility of farm during this phase
  • Early parts of this stage may include next generation working off farm to gain skills and contacts
  • Current generation may also need to develop the farm during this stage to cater for increased demands of a second dependent family
  • Payment to the new generation at this stage should be through a wage structure for services delivered


    Establishment

  • Two generations move towards mutual responsibility – through passing responsibility or creation of a second business encompassing some farm departments/enterprises or new departments with any new enterprise managed by new generation
  • Key is to have a formal decision-making processes, each generation playing equal role


    Withdrawal

  • As business management moves to new generation, current generation reaches a point of needing to step away from business
  • Usually one of the most difficult stages and can take up to five years to complete but does need to have a set end point.

 

 

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