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The Author Dr. Vinod Surana, is a trusted family business advisor, trained mediator, conflict management specialist, certified independent director and practitioner of law. He has qualified from Universities of Madras, Cornell and Harvard; the London School of Economics; InWEnt (Germany); AOTS (Japan) and the Indian Institutes of Management. He can be reached on +91-9488791000 / vs@lawindia.com

PART - I

1. SUCCESSION PLANNING IN FAMILY BUSINESS AND ITS RELEVANCE:
   Succession planning is a mechanism through which inheritance of leadership and management in family-owned assets/businesses can be preserved and managed efficiently.  Succession planning is important for preserving family wealth planning in advance, the future of family’s businesses. Several iconic international multi-national businesses started off as family businesses. 
   
   Think Ford Motors, Volkswagen, Dell, LG, Nike, Wal-Mart, BMW, Samsung etc. and closer home Tata, TVS, Birla Group, Reliance, Kirloskar, Murugappa Group, Jindal Steel and so many many more.  In-fact up to 90% of the worldwide GDP is generated by family businesses. India is a country where family businesses are predominant.  In fact, family businesses make up 79% of India’s GDP.  The traditional view on succession planning is focused on inheritance through a will and the wishes of a person after his death.  However, this method of estate planning is not necessarily conducive to all kinds of assets.  Historically, it has been found that most family disputes in relation to ancestral wealth arise out of testamentary dispositions.  The most unfortunate thing in such disputes is that they can go on forever and the wishes of the testator often do not materialize.

2. THE IMPLICATIONS OF THE RE-INTRODUCTION OF ESTATE DUTY:

Currently, India does not have Estate Duty or Inheritance Tax.  The current government has expressed views that estate duty (suspended in 1985), needs to be revived.  With steep fall in tax revenues due to the impact of Covid- 19 on the economy, chances of introduction of estate duty seem very likely as the government grapples with ways to tide over the crisis, by newer avenues of income and redistribute wealth amongst the classes. Estate Duty, (introduced in India in 1953), is a kind of inheritance tax payable by the inheritors of an estate. It is a tax levied on the total value of the property held by an individual calculated as on the date of death.

Estate Duty would be applicable when the property gets inherited.  One of the main objectives of an Inheritance tax is to prevent the accumulation of wealth in the hands of few people, thus reducing the economic disparity between the rich and the poor, a kind of “Robin-Hood Taxation”.  This means that the burden of taxes will fall heavier on a small segment of the population who are already burdened with taxes.  But there are legal ways to manage estates in a tax-efficient manner.  This points to the importance of succession planning and the role it plays in tax-efficient management of assets.

3. SUCCESSION PLANNING AND THE FAMILY BUSINESS:
   

“Your name is my name, my name is yours, everything is our’s, equally”

A family business is one which is owned and closely held by members of the same family with certain shared assets, shared ethos and ambitions that make it unique.  It is defined by its core business values which are marked by a strong culture, risk-taking ability, fast decision making and long term perspectives.  Typically started by a ‘patriarch’ the business is passed on from generation to generation.  This may start small but many have ended up growing to be multimillion-dollar multi-national conglomerates. 

Interestingly companies such as Samsung, Ford Motors, Tata Sons, Reliance are all examples of family businesses that have grown manifold since their inception and stood the tests of time. However, historically it has been found that most family businesses have not lasted beyond the 3rd generation.  It is apparent that not every generation will share the same ambitions and values.  Therefore, with each generation, there is bound to be differences in opinion on management and vision which trigger disputes and issues eventually leading to the demise of family businesses.  Therefore, Succession Planning is vital for every multi-generational family business.

The Hinduja Family scuffle

The need for succession planning for family businesses is aptly highlighted by the ongoing famous Hinduja family dispute.  The Hinduja brothers known for their family unity are at the forefront of a property battle that rests on a letter written in 2014.  On June 23, 2020, a UK court ruled in favour of Srichand Hinduja and his daughter Vinoo on the issue of control of Hinduja Bank, much against the wishes of former’s three younger brothers.  On 2nd July 2014, the four brothers signed a letter which said assets held by one brother belong to all and each brother will appoint the others as their executors.  Srichand and Vinoo went to the court stating that the letter should have no legal effect and cannot be used as a will or power of attorney.  Now that the Court has held the letter to have no legal effect it means that the Hinduja Family assets and businesses can be divided amongst the brothers, much against the greater wishes and ancestral values of the family. While the legal battle will continue, will it be ‘business as usual’ for all foreseeable time to come?

The Tata story

The Tata group is a global enterprise, headquartered in India.  Mr Ratan Tata retired in 2012 only to return in 2016.  that the leadership mantra of Mr Cyrus Mistry, to whom the baton was passed on, turned out to be vastly different from Mr Ratan Tata’s.  Primarily, Mr Mistry was selected as his family is one of the largest shareholders in the TATA group and was well known to the TATA group and family.  But Mr Mistry had never handled a large diversified group of companies spread across several countries and geographies.  No doubt, it is very important for such businesses to be sure that every successive leader shares the common vision and is armed with the experience required for the job.

Raymond's saga:
In 2002, Dr Singhania gifted his share of holding in the Raymond group to his youngest son Gautam.  This has been disputed and led to a humiliating legal battle between father and son. This is another classic case of the folly of not executing a proper and well-structured estate and succession plan.

4. THE ADVANTAGES OF SUCCESSION PLANNING: 

 - Now let us look at the advantages of succession planning:

1. Preserve value in the assets;

2. Develop a structure for the transition of wealth from generation to generation;

3. Ensure continuity of business;

4. Ensure tax efficiency;

5. Avoid family disputes; and

6. Avoid the risk of estate duty.
   
   

7. THE MAIN FEATURES OF SUCCESSION PLANNING ARE:

8. Separating ownership issues from management issues;

9. Create separate forums for family and business;

3. Institutionalize good corporate governance mechanisms;

4. Accountability & reporting to the Holding Company and shareholders;

5. Confidence and communication with shareholders;

6. Establish a family constitution to address key ownership and management issues;

7. Create clear lines between family and business;

8. Create shareholders protocols;

9. Devise a conflict resolution mechanism; and

10. Commit to fairness.
    
    

11. QUESTIONS TO ADDRESS BEFORE EMBARKING UPON SUCCESSION PLANNING:

12. Is the current business model sustainable for future generation?

13. Is professionalizing management required?

14. Does the next-gen want to continue the family business?

15. Are businesses goals in keeping with current trends?

16. What is the best structure to adopt for optimum tax planning?

17. How to plan for growth?

18. How to raise further capital?

19. How to divest current capital?

20. How to minimize conflict and disputes?

7. KEY ASPECTS INVOLVED IN SUCCESSION PLANNING:

The relevance of family constitution, & mission statement.

A family constitution is a formal document that sets out the rights, roles, responsibilities, rules and structures applying to all stakeholders in the family and provides plans and structures to deal with situations which arise in the course of operations in the family business.  Though this document can be put in place at any time during the life of the family business, it is advisable to do so at the earliest to provide clear direction and reason for their mission.

A well-strategized and well-written family constitution, though not completely enforceable on the successive generations, has a tremendous moral binding that courts cannot ignore.  It sets out the ethos of the business and provides for:

• mechanisms to encourage the next generation to participate in the business

• restrictions on the allotment or transfer of shares, often setting a minimum age at which the next generation can become shareholders/stakeholders

• who may be involved in the business and what happens in the case of family breakdown

• most importantly, mechanisms for dealing with disruptions and disputes arising from death, divorce, debts, deal disagreements etc.

The process of finalizing a family constitution can help identify and iron out potential difficulties and areas of conflict.  The family constitution should be reviewed periodically to ensure it reflects the views of current members.  

It has been found that a Trust is the best vehicle for succession planning. (The definition of trust, its types and benefits are listed in Part II below.)

When finalizing a trust structure one has to be mindful of tax and duty implications. For instance, gifts within the family and trusts can help families save considerable stamp duty.  Also, with the imminent scare of estate duty – efficiently planning the divesting of assets during the lifetime of a trustee can save on this aspect.

The Traditionalist View
The most important aspect of succession planning is choosing the best mechanism for distribution of assets & roles among future generations.  Somehow, traditionally the concept of succession to assets is linked to Wills.   A Will is effective after the death of the testator, i.e. the person making the Will.  This means that a Will as a final, binding document comes into effect after the death of the testator giving the persons involved no chance to express their desires or wishes.  This, more often than not, leads to major disputes between the heirs/successors. 

A Will is a required document when it comes to a person’s personal wealth, but is hardly the option for preserving value and distribution of assets for operational family businesses. Take for instance there are 3 brothers who are running a family business.  On the death of one brother if his heirs inherit his share in the family business and do not share the same business ideas as his father’s two surviving brothers it may lead to a crack in the family business.  Greater the asset pool, greater is the risk of disputes and, therefore, greater the need for succession planning.

As mentioned above, a Will takes effect only after the demise of the testator.  This does not happen automatically.  The Will would have a named executor who will administer the estate of the deceased as per the wishes in the Will.  The first step for the executor after announcing the existence of a Will, generally, is to approach the Court for a grant of Probate.  If the Will is uncontested the Court will be pleased to grant a Probate which in effect is an order that gives effect to the Will.   If on the other hand the Will is contested by any of the heirs, the probate petition gets converted into a long, acrimonious legal dispute. From the above, it is seen that succession planning can be a complex but essential process.  It is also crucial for business continuity. There are certain traits that a succession planning expert must have, such as:

impartiality & trustworthiness;
tremendous patience & expertise;
mediation skills to get the family on the same page (manage expectations);
ability to think out of the box and help vision formation;
understanding the family culture;
clarity of purpose;
maintaining checks and balances
being objective driven etc.

PART II –

TRUSTS, ITS TYPES AND BENEFITS:
For the efficient planning of succession from a legal and tax standpoint, trusts are seen to be one of the most viable options. It has been found that the best form of family wealth management is through the mechanism of trust.  A trust is a simple legal document that is governed by the provisions of the Indian Trusts Act, 1882.  The person making the trust is known as the ‘Settlor’, there are named ‘Trustees’ who manage the trust in accordance with stipulations of the trust document and finally, there are ‘Beneficiaries’ who benefit from the assets in trust according to the wishes of the ‘Settlor’.

- There are 2 main types of trusts:

1. Revocable Trusts – which as the name suggests, can be modified at any time by the Settlor. Revocable trusts also referred to as revocable living trusts, allow Settlor to maintain control of the assets during his/her lifetime.

Benefits of a revocable trust:

Such trust can be dissolved at any time.  A revocable trust offers flexibility since the transfer of assets and the guidelines specified are not permanent.  With a revocable trust, the settlor has the option to name him/herself as a trustee or co-trustee and choose someone to act as a successor trustee when he/she dies or is otherwise unable to manage the trust. Revocable trusts aren’t subject to probate.  That means the incomes from the assets held in the trust are distributed to beneficiaries without having to go through the probate court.  This allows for greater privacy than a will.  And it can be more difficult for creditors to claim assets held in a revocable trust in order to satisfy any outstanding debts that the settlor may have left behind.

2. Irrevocable Trusts: Such trusts cannot be modified, once made.  

Benefits of an irrevocable trust: 

This means less flexibility, but offers certain benefits such as protection of assets from claims of creditors, beneficiaries.  Also, an irrevocable trust can remove certain assets from the estate, saving them from the estate and gift tax.  That may be appealing if the settlor has a large estate and needs a way to minimize tax liability on those assets. 

Special Categories of Trusts
Within those two broad categories, there are a number of speciality trusts you can incorporate into your succession plan.

MARITAL TRUSTS
A marital trust can be established by one spouse for the benefit of the other.  When a spouse passes away, assets in the trust, along with any income the assets generate, are passed on to the surviving spouse.  A marital trust would allow the surviving spouse to avoid paying estate taxes on those assets during one's lifetime.  The surviving spouse’s heirs, however, would be responsible for paying estate tax on any trust assets that are eventually passed on to them, unless a further trust is created by the surviving spouse.  This is especially important in India where prenuptial agreements are illegal, except in the state of Goa.

CHARITABLE TRUSTS GENERATION SKIPPING TRUSTS
A charitable trust allows for setting aside certain assets for a specific charity or charities, and the rest of the assets going to beneficiaries as specified. A charitable remainder trust allows you to receive income from your assets for a set period of time, with any remaining assets or income going to a charity that you designate.

GENERATION SKIPPING TRUSTS
If you’d rather transfer assets to your grandchildren than your children, you can choose a generation-skipping trust. This type of trust lets you pass assets to your grandchildren, allowing your children to avoid paying estate taxes on those assets in the process. At the same time, you still have the option to allow your children access to any income that the assets generate.

LIFE INSURANCE TRUST
A life insurance trust is an irrevocable trust that you designate specifically to hold life insurance proceeds.  You designate the trust as the beneficiary of your life insurance policy; when you die, the policy proceeds are paid into the trust.  The trustee then manages the proceeds on behalf of your beneficiaries.  The advantage of an irrevocable life insurance trust is that it allows you to avoid estate taxes on life insurance payouts.

SPECIAL NEEDS TRUST
A special needs trust is designed to financially provide for a special-needs dependent –  a child, sibling or parent – without compromising their ability to receive government benefits based on their disability.  The money in the trust allows them to pay for medical care or day-to-day needs while also remaining eligible for the state disability schemes.

SPENDTHRIFT TRUST
A spendthrift trust may give you peace of mind if you’re concerned about your heirs frittering away their inheritance.  This type of trust allows you to specify when and how principal trust assets can be accessed by the trust beneficiaries, which prevents them from being squandered.  For instance, you may restrict beneficiaries to only benefiting from the income or interest earned by trust assets, but not the principal amount of the assets themselves.

TESTAMENTARY TRUST
A testamentary trust, or will trust, is established through a last will and testament.  The trust becomes irrevocable upon the death of the testator.  The main function of a testamentary trust is to ensure that beneficiaries can only access trust assets at a predetermined event.

As seen from the above, trust is an extremely versatile asset management and succession planning device which has many advantages including savings from the estate and gift taxes.  Through the mechanism of a trust, a closely held family business can continue to be held tightly by making the trust the holder of the promoter shares in the company, thus ensuring ownership control while management can be delegated.  This is one of the greatest advantages of a trust with respect to family businesses.  Since a trust offers a high degree of flexibility on personalization, a trust document can be drafted in a way to manage the affairs of a family business in an intricate manner so as to avoid any and all risk of conflict.

SHAREHOLDER’S TRUSTS:
This is a very important trust for family businesses, where the trust becomes the shareholder and the family members simply benefit as beneficiaries of the trust.  This ensures the longevity of the family ownership control over the family businesses.  Since trust is a very flexible instrument it can be drafted in a way where the family constitution of a family is consistently upheld. In the context of family businesses, it is the shareholder’s trust that comes to the fore.  By making the family trust the shareholders of the business you are able to safeguard the company from individualistic motives.  This is the most common form of a trust which manages all the aspects of planning for the future, from goal setting to tax planning and divesting.

PART III

Covid-19 and the future of the Family Business

From Part I and II of this article it is clear that the need for succession planning is essential for a family business to keep growing for generations.   It takes the role of the life-vest when businesses have to endure the tests and vagaries of times such as the coronavirus pandemic that has challenged businesses in the most drastic manner.  The current market scenario is like a war zone with companies easily falling off the wayside. The question in the minds of businesses, big or small, is how do we survive this?  What can we do better today so that we stay afloat & ashore?  It is important to keep your head above the water and learn from those who are growing in the times of crises.  Imagine how TATAs and Reliance are soaring.  Their grit, determination, agility and flexibility, under the umbrella of succession planning that keeps the generational differences at bay, keeps them going. 

DISCUSSION

Undoubtedly, it is now or never situation.  Your call to action is to get in touch with an experienced succession planning expert to help you achieve the following: 

Set specific, long-term goals for ownerships
Planning for succession should begin straight off.  Complexity in family businesses arises from the duality of side-by-side existing systems – family and business. The more closely aligned your goals, the more seamless the transition – which will help both on a business level, and a personal one.

Identify your next-generation leader
One should be on the lookout for a family member who has a professional trait and groom via exposure of professional life outside. Should the coming generation appear to be not interested in taking up the role then look outside the family for a suitable candidate.

Establish a set of managerial competencies
Draw up a list of the skills that you believe are essential in your role as a company owner, and that are must-haves for any successor.  This checklist can then be used to assess any potential successor, as well as help your current team understand what you're bringing to the company.

Evaluate the management team
Consider hiring a firm to evaluate top-level managers to assess and plan your management team and its future.

Identify the successors and lure them in
Once you have evaluated your management team and assessed their skills and performance, it’s time to start speaking with your top people about their careers and also to ensure that talent lower down the company has a path to commit to.

Work out a transition plan
Set the time period for your retirement and also the path of handing over to the next leader – when the transition starts to end on your retirement target date. Would the plan involve a change in the organization structure? To have a written framework for a succession plan as well as a dispute resolution ecosystem.

Family constitution implementation
To have a written framework for a succession plan as well as a dispute resolution ecosystem.

CONCLUSION

If to plan is to succeed, to fail to plan is to plan to fail.  In such a scenario it bodes well to start succession planning now. It is never too late to start.