Wealth Allocation: Who Should Be Shareholders Of The Family Business?
Care must be taken in ensuring that the intent of all the shareholders in the family business is aligned with the family members charged with managing and growing that business. Failure to do so could break the family business apart.
In last week’s blog, ‘Who Should Own The Business?’, I introduced the topic of ownership of the family business. And posed the question of whether equal ownership of the business by family members was the best choice. The blog also explored options for dealing with a business undertaking family succession and the various considerations that may come into play.
Today, we step forward and consider directly why equal ownership may not be the best choice.
The point at hand is simple. If some of the shareholders are actively working in and managing the business, and other shareholders are merely passive equity holders, you have the potential for conflict. And, if not conflict today, then conflict as the families grow and age.
Those working in the business may well wish to reinvest profits, pay themselves commercial salaries, including bonuses, and seek to grow the business in the long-term. Those passive shareholders may prefer to sustain and grow the dividend flow, pay lower salaries, and look for a good exit strategy.
This possible tension can increase as the next generation of family members grow up and look for career paths within or outside of the business, and also consider where capital may be freed up.
To ensure conflict does not arise between shareholders, families often elect that only family members working within the business can hold shares.
Prima facie this can remove the potential for conflict, however, there is no guarantee that these original shareholders will continue to be actively involved in the business in the future. Such a decision can also lead to a sense of inequity between those who are in and those who are out of the business.
If this is the course you considering following, then an open and frank discussion with the next generation will be essential to ensure their willing support of this approach. Failing this, you may be creating a festering sore that will cause significant disunity when the next generation is in control.
Whatever choice a family may make regarding the holding of shares, the underlying safeguard against conflict is the creation of a well-drafted shareholders’ agreement, including a governance structure, that will underpin equity, unity and a well-managed business.
Tomorrow, I will review what aspects that agreement and structure should cover.