October 23, 2017
”Family constitution” or how to transfer business smoothly

The American business magnate, investor and philanthropist Warren Buffett once said in an interview that he would leave his children ‘enough money so they would feel they can do anything, but not so much that they could do nothing’.

Passing on a business is not only a gift to future generations, but also a great responsibility. Heirs who inherit high value assets may lose the motivation to strive, improve and achieve something themselves. Often it is a case of wasting wealth rather than boosting it. Reckless business transfers can endanger the continuity of the business, and undermine the interests of business partners, employees, and even the public. How can you find the ‘middle ground’ in passing on business? It is much more complex than transferring an apartment, a car, a garden, household items or money in a bank account. Businesses have been passed on abroad from one generation to another for hundreds of years, but in independent Lithuania this practice is only beginning to develop. The tools available in the country’s legal system do not always create a basis for achieving the best result in business transfer, often creating conditions that interfere in the process of keeping the business in the family. Regardless of which specific tools you choose, it is important to understand that business transfer, like the business itself, is a long process that requires a good strategy, preparation, and consistent implementation.

Gediminas Laucius, Tax and Legal Director at Lewben Group

The first step towards the successful transfer of assets is to make an inventory of the assets. This step is important not only to the party doing the transfer, but also to the recipients, so that they know everything about the property, and, if necessary, receive it from third parties who are managing the property on behalf of the owner. During the inventory process, you must ascertain:

– How much and what assets there are

– In which jurisdictions they are

– What asset classes they belong to

– How they are managed: directly, through controlled legal entities, on the basis of informal agreements with business partners, or through independent trustees.

– What kind of debts and/or liabilities are related to the assets.

Different asset classes often require different solutions. It is necessary to know the exact composition of the whole asset, so that decisions taken later are in line with the aims of the business owner, and are efficient from a commercial, regulatory and fiscal point of view.

2. Knowing the composition of the property and the aims of the owner, you can proceed to creating a specific plan. This should include the financial, investment, legal, tax and educational aspects. The structure of the business and property may consist of different assets, often located in different countries, with different commercial environments, and may be subject to different regulatory requirements. Therefore, it is very important that the plan is individual and tailored to the specific business and property circumstances. You might find one solution that ensures financial returns from investments, but a different solution will be needed in order to maintain control of the core business, and to ensure that after the transfer it will continue to be managed professionally and profitably.

3. When designing a plan, an important step is to choose the right tool for transferring the assets. There are ways to transfer property, but you have to be properly advised by taxation and legal specialists. As well as the usual will, which unfortunately is not the most effective means of transferring business, the law in Lithuania and in some other foreign countries offers alternative measures that allow for the special business objectives of the transferor:

– A donation contract. This allows for the transfer of property between relatives without negative tax consequences while the owner is still alive. The Civil Code of Lithuania provides the possibility to demand the gift back if it is used for purposes other than what was agreed. A properly structured donation transaction allows the business owner to transfer property to his heirs while he is alive, and, through additional security mechanisms, ensure that the heirs use the gift properly.

– A support/maintenance contract. According to the agreement, the supporter (debtor) undertakes the responsibility to periodically pay another party, free of charge or in exchange for the transfer of capital, a contractually agreed amount, or otherwise support the payee. A support/maintenance contract can be used as an instrument to ensure that family members will be taken care of after the death of the owner of the business. This is especially useful if there are vulnerable people in the family (for example, people with special physical, economic or social needs).

– More sophisticated tools are used abroad. In order to ensure that control of the business is not split between different heirs, and that the business and its returns are distributed fairly among the family, special family funds or trusts are often used. Professional trustees own assets and control them for the benefit of family members. Such funds and trusts make it possible to separate legal property from economic property, thus allowing family members to become involved in the management of the business through positions held in funds or companies. Family members receive financial benefits from successful business activities, but this type of agreement does not allow individual heirs to freely dispose of inherited wealth (for example, by selling).

4. When planning a transfer, it is very important that the plan not only addresses the business transfer but also the current management of the assets. Therefore, the property transfer plan should not be considered an inheritance plan. A business transfer plan should be useful at the current stage. A complex asset inventory and the use of advanced legal instruments for asset consolidation can help to reduce the risks associated with old and obsolete structures, improve business management efficiency, and increase the value of the entire business.

5. It is equally important that the plan is dynamic, and is prepared taking into account specific current commercial and personal circumstances. However, changing circumstances should not make a plan obsolete. It must adapt and remain relevant in order to achieve the original goals, taking into account the fact that personal circumstances (marriage/divorce, the birth of a child, death), the composition of the assets, borrowing conditions and other commercial circumstances, the regulatory environment, and the geopolitical situation may change.

6. The most important step is developing heirs to take over control of the business. This step requires consistent and long-term preparatory actions:

1) develop an interest in the heirs in taking control of the business;

2) provide the heirs with education;

3) create conditions for them to acquire professional experience, understand the specifics of the particular business; and

4) develop leadership qualities.

Coordinating the entire process might require the efforts of more than the business owner: the involvement of external advisers, such as financial, legal, business and even psychologists, might be needed. The implementation of the plan should involve the relatives at the earliest possible stage, so that they know the goals and values of the owner of the business. Such advance communication will allow offspring to prepare to take over a business in the future, will help avoid disputes between family members, and ensure that the family share the same vision and common desire to implement it. Therefore, a well-prepared business transfer plan should be considered a ‘Family Constitution’.

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