Methods for avoiding disputes in the case of business succession
Legal disputes in connection with business successions are on the increase. This applies in particular to disputes under inheritance law, company law and tax law. Disputes in connection with a business succession cost the parties involved a lot of time, money and energy due to their complexity and considerable economic importance. At the personal level, they also harbour a considerably increased potential for stress and conflict for those involved, especially if the business succession was arranged within the family. The company itself is also usually affected by the disputes. At best, the disputes only cripple the economic development of the company. In the worst case, however, they also put the company itself at risk, even to the point of going out of business. The avoidance of disputes in the context of business successions is therefore of considerable importance in the planning and structuring of such successions.
Starting point for business succession
From the point of view of the business owner, business succession is a decisive component in their life planning, especially family wealth planning. It is not uncommon for the business being transferred to represent the life’s work of the business owner, which they have to “let go”. Furthermore, the business to be transferred is a substantial, if not the essential, asset of the business owner, which ought to be preserved within the family or realised by selling it to a third party. At the same time, the solution to be found should be fiscally favourable, and where the successor generation is involved it ought to be fair. Emotional and rational aspects come together, and special attention must be paid to this. Furthermore, in most cases, the intended business succession is a one-off process without any previous personal experience on the part of the business owner. For the business owner, it is crucial that the successor has the aptitude to continue the business successfully. At the same time, the business owner has to deal with the question of whether promises made by the successor will actually be kept and how he/she intends to deal with them if they are not kept. If the business owner retains a full or partial legal or economic interest in the business, they also bear the risk that the successor will make risky decisions, which could be detrimental to or against the interests of the business owner. For the successor, on the other hand, taking over the company is a future opportunity that binds them in the long term, with all the associated costs and risks. For the successor, therefore, the question arises as to whether the business to be taken over actually has the value or potential attributed to it by the business owner. Due to the high economic importance of a business succession, the expectations and goals of the parties involved are thus very high. On the other hand, the potential for personal and economic conflict and escalation is logically just as great if the implementation of the agreed business succession turns out to fall short of the associated expectations and goals of those involved. A well structured business succession must therefore identify the respective interests, goals, opportunities and risks of the parties involved and bring them into an appropriate balance.
Typical process of a business succession
A “planned business succession” typically consists of three phases, namely the preparation, negotiation and implementation of the business succession. In the first phase of preparation, the fundamental decision is made regarding the potential transfer of the business. This is accompanied by a business valuation and an asset inventory. The goals, risks and expectations of the business owner with regard to the planned business succession and the possible successor are determined and prioritised. Already at this stage, tax and legal alternatives for action and design should be identified on the merits of the case in order to achieve these goals, and included in the further planning and decision-making process. In the negotiation phase with the potential successor, the preferred structure of the business succession and the associated contractual arrangements are negotiated and decided, taking into account their economic, legal and tax consequences for the parties involved. Parallel to this, financing options for paying the purchase price are being examined. At the end of the negotiation phase, the succession contract is concluded. The implementation phase includes the introduction of the successor within the company and to contractual partners, as well as payment of the purchase price.
An “unplanned business succession”, e.g. due to serious illness or death of the business owner, significantly increases the risk to the business, as well as the risk of disputes. There is limited legal, fiscal and economic freedom to adapt the structure of the process. Many parameters are already fixed and cannot retroactively be changed. This applies in particular to fiscal structuring. In the worst case scenario, the company is left without management and without an option of quickly taking countermeasures via the shareholder position. The emotional strain and pressure on those involved is particularly high in such an emergency situation. Ultimately, unplanned business succession carries a higher risk of error in the structuring and implementation of the business succession due to the associated time pressure.
Methods for avoiding conflict
- The planning and implementation of a business succession is a complex and lengthy process that is usually tackled parallel to the day-to-day business of the business owner. The business owner should therefore address this issue in good time and allow sufficient lead time for planning and implementation. This also includes having an emergency backup plan, in particular by granting appropriate powers of attorney for use in the event of an accident or similar, in order to at least avoid the threat of the company potentially becoming leaderless.
- It is important to carry out a complete as-is analysis of the company’s operational situation and the business owner’s economic and legal situation right at the beginning. It is also required to determine the goals and expectations of the business owner in relation to the intended business succession in this specific case, and what priority the business owner gives these. These two activities are interdependent. They are part of a progressive process leading to the conclusion of the contract, which will change, in the course of the further planning and decision-making regarding the manner of the business succession and must therefore be reconsidered and adapted again and again. At the latest when the potential business successor is at the negotiation table, the parameters will need to be adjusted to their expectations. One should be prepared for this. The individual nature of the business and the persons involved make every business succession an individual process, so that a standardised solution is excluded. The best possible tax structuring option in the context of a family business succession may, for example, lead to disputes later on within the successor generation due to alleged or actual unequal treatment, or because the liquidity interests of the business owner were not sufficiently taken into account. Only when based on complete information will it be possible to take the necessary preparatory measures, resolve conflicts of objectives and interests, exclude or reduce risks, fully exploit legal and tax structuring options, and avoid disputes.
The transparency and completeness required in the decision-making process are also the reason why consultants, e.g. tax advisors, lawyers, and business and investment advisors, should be involved in the planning and decision-making process from the outset, albeit with different weighting, in order to avoid information asymmetries and deficits, and thus mistakes.
The family of the business owner should likewise be involved in the business succession considerations at an early stage. This concerns not only the potential successor from within the family, but all family members. This is because the decision on business succession ultimately affects every family member, albeit in different ways. There should therefore be agreement on who from the family is ultimately affected and in what manner, and whether or in what manner they should be involved in the business succession process. Decisions.
Discussions and negotiations in the context of business succession are characterised by the fact that they involve economic, tax, legal, and also personal factors. In practice, it has been shown that these factors are often strongly interlinked or mixed by those involved, which makes solutions more difficult. Regardless of which of these levels the business owner prioritises, care should therefore be taken to ensure that problems and issues are discussed at the level at which they are focussed. One should also remember that a solution which one personally considers balanced and fair, e.g. regarding compensation payments to potential successors from within the family that step back, may not be regarded as fair by the latter. However, it cannot be denied that an excessive focus on equal treatment can limit design options, especially regarding the exploitation of tax advantages. This is another reason why it is important to involve family members at an early stage in order to reach a sustainable agreement.
Business succession also has a significant impact on the company’s other stakeholders, such as employees, suppliers, customers, and even financing banks. A business succession fundamentally results in significant changes in the company, as well as product and process innovations, because the successor wants to implement their own ideas regarding the future development of the business. Employees should therefore be involved in a timely manner, in order to avoid jeopardising the economic success of the planned business succession. In many cases, it is also evident that the business owner’s willingness to invest has been reduced in the run-up to a business succession. The house banks are therefore the first point of contact as lenders to finance the investments planned by the successor. Here, too, early involvement of the banks is therefore recommended.
- If it is wished that the business owner continues to be involved in the management of the company, be it as managing director, consultant or shareholder, it should be clarified what tasks, responsibilities, and remuneration this should involve, and over what period of time. In this context, it must in particular be taken into account that the business owner remaining within the company may not be exclusively beneficial for a business succession, because it may impede the successor in growing into the new role, making it more difficult for them to be accepted by employees and third parties.
- Contractual provisions should clearly, unambiguously and fully regulate the business succession in order to avoid disputes later on. For this reason, it should also be clearly mapped out what will have to be done if certain commitments or expectations of the parties are not fulfilled. In the context of a non-family business succession, this applies in particular if a complete takeover of all shares in the business does not take place immediately, if the purchase price is variable, or if an instalment payment is agreed.
Business succession is a difficult and complex process, which needs to cover a multitude of different personal and economic interests. Business succession is also burdened with a considerable forecasting risk and is of significant economic importance for the parties involved. For this reason, the success of the business succession is decisively reliant on finding a clear and contradiction-free means of structuring the business succession, based on complete information and adequately defined goals. There is otherwise a risk of long and costly disputes, which ought to be avoided at all costs.
About the author
Uwe Müllner specialises in assisting with complex (arbitration) disputes in the field of commercial and corporate law.
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Publication: E-Book „GmbH-Geschäftsführung 2022″
Publication date: 23. June 2022
Publisher: EUROFORUM Deutschland GmbH