Use of trust structures as solution to succession planning problem

Family businesses have the potential to become veritable pillars of the Nigerian economy just as small businesses have been, on more than one occasion, referred to as the backbone of the US economy.

In most cases, these businesses are often caught in the trap of inadequate succession planning strategies or the complete lack of it, in this interview with BusinessDay, Ifeoma Udom, managing director of Vetiva Trustees Limited, makes a case for the use of trust structures as solution to the dilemma of succession planning and growth for family businesses. Excerpt:

The odds appear to be against the survival of family businesses after the death or exit of its founder. Why do you think that is the case

I quite agree with you. If you take a look at the business environment generally, you will find that most family and closely held businesses, both large and small, in Nigeria and worldwide, fail to evolve into multi-generational businesses despite the natural expectation by most business owners that generations after them will continue to control and manage their businesses successfully. This disconnect, in my view, is partly as a result of the failure to plan for the succession of the business, as the issue can simply not be left to chance.

This failure to plan, can be traced to the fact that most entrepreneurs are unwilling or unable to properly address this pertinent issue either because of their desire to remain positive about having a long, healthy life or their preoccupation with the continuous growth of the business under their watch. In actual fact, succession planning should be viewed as an inevitable mechanism required for the continuous existence of any sustainable business.

In addition, what we find is that the majority of the few that attempt to plan for the succession of their businesses take text book approaches without having full regard to the more delicate and peculiar issues pertaining to their own families.

What is this succession process you refer to? How do you plan towards it

Succession planning is the deliberate process of identifying and preparing the appropriate person(s) with the potential to fill key roles in the business both in terms of ownership and management. If you notice, the definition I have given indicates two distinct aspects, which many erroneously assume are one and the same: Ownership Succession Planning and Management Succession planning.

The former relates to the actual transfer or transmission of the shares held in the Company or the portion of the business held in a partnership or other entity from the existing business owners, while the latter relates to the handover of the day-to-day running and management of the business.

Give a little more insight into the two aspects of Succession Planning you mentioned.

Management succession planning, involves the process of identifying a competent individual or a small group of persons who will be in charge of the management and supervision of the three essential elements of any business – business development, operations and administration. Those are what make the family business an asset worth preserving.

Bearing in mind that the next generation of the family in itself may not have the resources or the will to fill all such management positions, trust structures in the form of Management Stock Option Plans or Employee Stock Benefit Plans, for instance, can be used to incentivise such management personnel, family members or otherwise, to continually build the business for generations to come.

Ownership succession planning, on the other hand, must be carefully thought through with the help of estate planning professionals, as well as accountants, solicitors and tax consultants. Most commonly, an attempt to plan for ownership succession without competent professionals will most likely lead to technical errors, which are likely to result in significant cost or prolonged litigation amongst disgruntled family members, which can and most often does potentially affect the survival of the business.
Just as with Management Succession planning, part of the solution would be found in the use of one or a number of trust vehicles, which are usually quite effective in handling succession planning. This is especially so where it is important to distinguish between controlling shares, to those in charge of the business and equity benefits, to heirs, spouses and dependents that may not be involved in the running of the business.

You have mentioned the use of Trust Structures in carrying out succession planning. What are these structures, and how dores, and how do they work

The list of trust structures and vehicles that can be used in various scenarios is endless and ever increasing as the diverse family situations, expectations and dynamics will require different structures to suit each case.

Primarily, there would usually be a family trust, which will serve as the umbrella vehicle under which the various companies and other family assets will be held for the benefit of the entire family. Under this, we are likely to have various other structures depending on the complexity of the family structure and the nature of the business or businesses and the risk management issues requiring attention.

Also, I had earlier mentioned Employee Stock Option Plans and Employee Stock Benefit Plans, when we were discussing Management Succession Planning. An Employee Stock Benefit Plan, generally speaking, is an arrangement where employees are given an opportunity to receive or benefit from the equity of a Company based on preset conditions. They are typically structured to incentivise employees who show commitment to the objectives of the company in the medium to long term.

There are several types of ESOPs; but broadly speaking, there are four major categories namely Share Awards Schemes where shares are given away free-of-charge on laid down conditions, Share Purchase Schemes where shares are paid for by the employees usually at a discount, Share Options which is the grant of the right but not the obligation to purchase shares in the future at a price set before hand and Phantom Equity Schemes which is the award of benefits tied to the equity of the Company without the grant of the shares themselves. A first step in determining which option to go for would be to clearly define the business owner’s intentions and Company’s needs. Although time will not permit us to focus on each of the types of Employee Stock Ownership Plans, to discuss their pros and cons and highlight the ideal situations for their use, there is no doubt that their use is far more effective than the direct allotment of company shares to individuals, thereby running the risk of having company shares held and controlled by persons who may no longer be loyal to the business.

However, we cannot emphasise enough the fact that there is no “one size fits all” rule in the application of these, as what works for one family business may be inappropriate for another.

Recognising that a business has to be thriving to survive generations, are there any benefits to the use of trust structures in growing family businesses

With the increasing severity of the economic climate, where small businesses must either grow or be eroded by bigger players, some business owners may consider expanding the business – an endeavour that would most likely be capital-intensive and require significant leverage, perhaps, from more than one bank.

However, what you find in most cases is that a majority of these business owners may have become overly exposed to one bank and have practically all their assets tied up as collateral for the bank facility, a situation which significantly hinders their capacity to grow the business exponentially as they are limited to the terms and conditions of the initial facility provider regardless of the extent to which they have reduced their exposures and increased the value of their assets.

Thus, such business may be unable to take on additional facility from another bank with better pricing. For such business owners, we usually recommend the set-up of a security trust structure, where all the assets it intends for use as collateral or security for facilities will be placed under a Trust and held as a common security by the Trustee on behalf of the Lenders. In such a situation, the business owner is better able to manage his exposure to Lenders in a way that allows for the sustainable growth of the business.

Are there any other solutions Vetiva Trustees has for family businesses

There are several. One area that readily comes to mind is that generally, business owners in making their succession plans, may consider not only leaving a legacy for their heirs and other beneficiaries, but may also desire to make a long-lasting impact on society in an area of community development through setting up a private foundation or establishing an endowment fund to encourage the younger generation or less economically-empowered members of the society in a particular profession or passion or other vocation.

In the short term, however, it may be a considerable challenge juggling their need to focus on building their businesses with achieving this aspiration, that most of these business owners never get round to it. In addition, focusing on the long term, what we find in many cases is a situation where such well-meaning individuals formally or haphazardly engage in philanthropic activities or corporate social responsibility initiatives when they feel financially buoyant and put a halt to it when liquidity is challenged, failing to realise that this well-meant activity could result in reputational damage to their businesses and persons if not handled professionally.

In actual fact, the creation of a charitable legacy requires a well thought out structure and funding strategy to ensure sustainability and long-lasting impact. This is where our philanthropic advisory services and solutions become relevant, which is ancillary to our primary trust business.

At Vetiva Trustees, we take on various services in this regard, right from the point of assisting in the formulation and articulation of the Foundation’s or endowment’s objectives, assisting in undertaking the registration of the legal structure as well as other regulatory compliance activities, through to the actual management and administration of the philanthropic structure in a sustainable manner, whilst ensuring that cash management is efficiently supervised with due regard to short- and long-term goals.
This helps in ensuring that selected investments achieve the key requirements for successful foundations and endowments such as adequate funding to meet set objectives while preserving the fundamental investment.

Tell us a bit more about what you do at Vetiva Trustees.

Vetiva Trustees is a corporate trustee business with an unwavering commitment to consistently deliver exceptional Trust advisory services and bespoke solutions to our clients in a sophisticated and innovative manner, being part of the Vetiva brand whose essence is passionately professional. At Vetiva Trustees, we do not just pay lip-service to corporate governance and compliance issues as it relates to our business, our clients and the trust assets under our management, but make it our mission to ensure value is added to the lives and asset portfolios of every one of our clients, whilst adhering strictly to a proven risk management framework.