Family businesses unquestionably form the backbone of the Maltese economy. From small family-owned retail outlets to larger family-established companies or groups of companies operating high-tech industrial facilities for the manufacture and export of sophisticated consumer goods, world-class breweries and beverage bottling facilities, five-star hotels, and large real estate developments, the family unit has always been of critical importance- not only to the development of Malta’s social fabric but also to its economic development over the past two centuries. And this importance is only increased by the consideration that employment in the private sector is largely accounted for by family-owned businesses.
Like any other businesses, the dynamics at shareholder level have a significant influence on the way the business operates. Thus, for example, a private-equity owned company seeking maximisation of profits as its primary goal is bound to be run quite differently to a family-owned business passed down three generations which will be more intimately connected to the very market that it services. This connection typically brings a stronger social and ethical dimension to the conduct of that business, whereby the pursuit of profits are generally not the sole objective and other social considerations are brought to the fore. One typical example from Italy, which is close enough to home, would be FIAT which has had a significant impact on both the social and economic development of Torino over the years.
It is also true, however, that shareholder dynamics within a family business are often complicated by the fact that shareholders are not only participants in a collective business venture, but also members of the same family unit, with all the associated dysfunctions and idiosyncrasies which such relationships bring. The family unit involves emotions and behaviour that would rarely be found between unrelated business partners- emotions and behaviour created on a personal and family level and which are inevitably brought into the business and very often hinder the proper running of that business. Common examples would be the hitherto prevailing practice of excluding female family members from family businesses ostensibly due to their home-making commitments, and key leadership functions being occupied by family members on the basis of their gender, age or line of descent, rather than on the basis of objective assessments of merit, suitability and skill.
As legal advisors to several local family businesses, both large and small, our firm is regularly involved in succession-related issues which must be addressed on an on-going basis. The passing down of ownership and control from one generation to another is always a highly sensitive affair. The careful handling of such situations necessitates the involvement of experienced external advisors to facilitate the succession process, through the creation of appropriate structures, mechanisms and protections intended to safeguard not only the interests of the shareholders and family members, but most importantly the preservation of the long-term interests of the family business in question.
In many cases options such as buy-outs and consolidation of shareholding should also be carefully considered as possible routes to ensure that every family member’s interests can be addressed to the fullest extent possible.
Typical considerations faced by external advisors when handling a family business succession plan include the following:
- Preservation of the financial benefit derived from the business by older members of the family to preserve their post-retirement quality of life;
- Sensitivities of older family members relating to the relevance of their knowledge and experience in a modern business environment somewhat far-removed from the prevailing environment at the peak of their careers;
- Conservative outlook on the part of older generation family members which impairs the undertaking of new investments, distribution channels or business methods;
- Fragmentation of shareholding created by the multiple divisions of shares amongst siblings or family members, creating the risk of regular divergences in the objectives of the business in question;
- Raising of finance from external sources for capital expenditure or working capital requirements;
- “Power struggles” between family members to occupy key executive roles within the business;
- Methodical handover of key external business relationships from one generation to the next;
- Family members who lack commitment to the family business or do not contribute to the same extent as other family members expecting equal financial reward for their work;
- Rigid remuneration structures which are based more on seniority within the family unit rather than on skill, capability, commitment and/or effort;
- Unsophisticated corporate governance practices, including irregularity and/or informality of board meetings, absence of non-executive directors and lax internal controls;
- The cost of reorganising shareholding due to capital gains and duty on documents liabilities due upon the transfer of shares from one family member to another.
The list goes on.
Whilst several of these considerations can be managed effectively through the involvement of the appropriate legal, accounting and tax professionals, it is clear that the commitment of older family generations is critical for the success of any transition of ownership and control of a family business. In cases where older generations pay lip service to a succession plan “in principle” but fail to follow through with action to implement the required changes, real risks of material and irreversible damage to the family business are created as internal dysfunctions distract the family members from their business.
The Maltese Government’s recent initiative of introducing various incentives through the Family Business Act has been favourably received by the local business community. A significant number of local family business have availed themselves of the benefits introduced by the Act, particularly the reduction in the duty on documents and transfers applying to transfers of shares by existing owners to their descendant family members. Indeed, the original deadline of the 31st March 2018 was extended to the 30th September 2018 to accommodate the large influx of families that have taken up this opportunity to reorganise themselves. Many of the families that we have advised through this process have applied a mechanism of donating the shares in the family business to their children (next-generation), whilst retaining a right of usufruct so that the benefits of dividends and voting rights remain vested in the donor for a period of time, typically vita durante.
Families that have not yet considered the benefit of availing themselves of the benefit within the time-window of the 30th September 2018 are strongly advised to speak to an advisor of their confidence to understand the benefits, mechanisms and implications of the process. At the time of going to print it is still unclear as to whether or not a further extension to the 30th September deadline will be applied. Whilst this procedure will not serve to address wider governance and organisational issues, it certainly helps families empower the next generation through the vesting of ownership of the family business (albeit subject to the usufruct) and pass on the proverbial baton.
The complexity of managing a succession process carefully and correctly cannot be overstated. Families looking to rethink their internal ownership, governance and organisational structures would be advised to seek professional guidance at an early stage from advisors enjoying the confidence of all family members so that the interests of all involved can be managed as smoothly as possible. The alternative of having divisions and factions created within the family unit very often threaten the integrity of the family business not only economically but also on a familial level.