Family businesses are often built on trust.
Parents, children, siblings and other relatives may work together for years without feeling the need to formalise exactly how the business should be owned or managed.
That can work extremely well until circumstances change.
One family member may want to leave the business. Another may want their children to become involved. Siblings may disagree about salaries or dividends. A shareholder may die or divorce. One branch of the family may work full-time in the company while another owns the same number of shares but has little involvement in the business.
These situations can turn a family disagreement into a serious shareholder dispute.
A properly drafted shareholders’ agreement for a family business can help prevent that by establishing clear rules while relationships are good.
For an Irish family-owned company, the agreement should address not only how the company operates today, but also what happens when ownership passes from one generation to the next.
It can be tempting to think:
“We are family. We don’t need an agreement.”
In reality, family businesses can have an even greater need for clear shareholder arrangements.
The relationship between shareholders is not purely commercial. Family relationships, employment relationships and ownership of the company can all overlap.
Consider a business established by two parents.
Twenty years later, their three adult children may all own shares.
One child is managing director and works 60 hours a week in the business.
Another works part-time.
The third has pursued a completely different career and has no involvement in the company.
Should all three receive the same financial return because they own equal shares?
Should the child running the company receive a larger salary?
Can the non-working shareholder sell their shares?
What happens when the next generation becomes involved?
Without agreed rules, questions like these can become highly personal.
A family business shareholders’ agreement can separate the family relationship from the rules governing ownership and management of the company.
One of the first questions is whether ownership should remain within the family.
If that is the intention, it should be considered expressly.
Under the Companies Act 2014, transfers of shares are subject to restrictions contained in the company’s constitution.
A shareholders’ agreement can provide additional contractual arrangements governing when and how shareholders can transfer their interests.
For example, the shareholders might agree that shares cannot be transferred to an outside party without first being offered to other family shareholders.
These pre-emption rights can give existing shareholders an opportunity to keep ownership within the family.
The agreement should consider:
The objective should be to avoid the family discovering the answers only after somebody has decided to sell.
This distinction is extremely important in a family company.
Being a shareholder does not necessarily mean being entitled to employment in the business.
Likewise, being employed by the family business does not necessarily mean that somebody should receive shares.
The shareholders’ agreement should help distinguish between:
ownership of the business, and
employment in the business.
Suppose three siblings each inherit one-third of their parents’ company.
One is the managing director. One works elsewhere. The third wants to join the business and expects a senior management position because they own one-third of the shares.
That expectation can create conflict.
A family business should therefore consider establishing clear principles concerning who can work in the company and how family employees are appointed, promoted and remunerated.
Positions should ideally reflect the needs of the business rather than simply family ownership.
Money can become one of the most difficult issues in a family business.
It is important to distinguish between salary and dividends.
A family member who works full-time in the business may receive a salary for the work they perform.
A shareholder may potentially receive dividends by virtue of their ownership, subject to the company’s legal and financial position and the rights attaching to their shares.
Those are different concepts.
Problems can arise where some family shareholders work in the company while others do not.
For example, a shareholder working full-time might feel that they deserve a significantly higher salary because they are responsible for growing the company.
A non-working shareholder might believe that profits are being extracted through directors’ salaries instead of being distributed as dividends.
The shareholders’ agreement can establish principles governing:
Clear rules can reduce the risk of commercial disagreements becoming family disputes.
A family business needs a workable decision-making structure.
The shareholders’ agreement can identify reserved matters requiring approval from a specified percentage of shareholders.
These might include:
This can be particularly important where one family member manages the company on a day-to-day basis but ownership is spread across several relatives.
The managing director needs sufficient authority to operate the business effectively, while the other shareholders may reasonably expect a say in decisions that fundamentally affect their investment.
Family business succession planning should be considered well before the founder intends to retire.
A founder may have three children but only one may actually want to run the business.
Does that mean all three should inherit equal shares?
Should the child working in the business have control?
Should children who do not work in the company receive economic rights without management control?
What happens if none of them wants to run the company?
These are not questions that a shareholders’ agreement alone can necessarily resolve.
Succession planning may involve the company’s constitution, shareholders’ agreement, wills, tax planning and other arrangements.
There can also be significant tax considerations when transferring a family business.
Revenue currently provides Business Relief from Capital Acquisitions Tax for qualifying gifts and inheritances of relevant business property, including qualifying shares in certain circumstances. Where the conditions are satisfied, the taxable value of qualifying business property is reduced by 90%. The relief is subject to detailed conditions and can also be withdrawn in specified circumstances.
Legal and tax advice should therefore be coordinated before ownership is transferred to the next generation.
Family members’ plans change.
A son or daughter who expected to spend their career in the family business at 25 may want to leave at 40.
A sibling may want to cash out their investment.
Another shareholder may want to retire.
A shareholders’ agreement should establish a clear shareholder exit mechanism.
Questions include:
The last point is particularly important.
A family business may be extremely valuable without the other shareholders having sufficient personal cash to purchase a departing shareholder’s interest immediately.
The agreement should therefore provide a commercially workable solution rather than simply assuming that somebody will have the money when the time comes.
Share valuation can become one of the most contentious issues in a family shareholder dispute.
Suppose two siblings each own 50% of a company.
One wants to leave.
They agree that one sibling should purchase the other’s shares but disagree completely about what the company is worth.
The shareholders’ agreement can establish a valuation procedure in advance.
It may address:
Agreeing the mechanism before anybody wants to leave can remove a major source of conflict.
Death is particularly important in a family-owned company.
Shares do not simply disappear when a shareholder dies.
The deceased’s interest must be dealt with as part of their estate, subject to the company’s constitution, shareholders’ agreement and applicable succession arrangements.
The family should decide in advance whether the intention is for shares to pass to the next generation or whether surviving shareholders should have the opportunity—or in an appropriately structured arrangement, an obligation—to acquire them.
These arrangements should also be considered alongside the shareholder’s will and succession plan.
For qualifying business property, Business Relief from CAT may potentially be relevant to an inheritance, but the statutory conditions need to be satisfied and tax advice should be obtained.
Family businesses should also consider the possibility of a shareholder’s marriage or relationship breaking down.
The precise legal consequences of divorce or separation will depend on the individual circumstances and applicable family law.
From the company’s perspective, however, the shareholders should consider the extent to which they want to protect the ownership structure of the family business.
Share transfer restrictions, pre-emption provisions and succession planning should therefore be reviewed as part of the overall arrangements.
Specific family-law advice may also be required where a separation or divorce actually occurs.
No shareholders’ agreement can prevent family members from disagreeing.
It can, however, determine what happens next.
The agreement could establish a dispute resolution process involving:
The objective is to prevent a disagreement from paralysing the company.
This becomes especially important where ownership is divided equally.
For example, two siblings owning 50% of a company each may reach a point where neither can make important decisions without the other.
A well-drafted deadlock clause can establish how that situation should be addressed.
Some larger family businesses may also consider a family charter or family constitution setting out broader principles concerning the family’s relationship with the business.
This is different from the company’s legal constitution under the Companies Act 2014 and should not be confused with it.
A family charter might deal with matters such as:
However, a family charter should not be treated as a substitute for appropriate legal agreements.
The company’s registered constitution has statutory effect under section 31 of the Companies Act 2014, binding the company and its members as provided by that section.
The shareholders’ agreement, company constitution, wills and succession arrangements should therefore be designed to work together.
This is one of the most important issues to address as a family business passes through generations.
The first generation may consist of two founders who both work full-time.
The second generation might contain four shareholders, only two of whom work in the business.
By the third generation, there could potentially be numerous shareholders with very different levels of involvement.
The family should therefore consider whether future ownership should automatically follow family relationships or whether there should be conditions attached to ownership.
It should also consider whether the business requires different arrangements for:
The structure that works for a founder-owned company may not work when ownership is spread across ten cousins.
This is ultimately a decision for each family, but equal inheritance does not necessarily produce simple business governance.
A parent may understandably want to treat children equally.
However, giving three children equal shares in a company can have very different consequences where only one intends to devote their career to the business.
Equal economic treatment and equal control of a company are not necessarily the same thing.
Before transferring shares, families should consider the long-term consequences for:
There may be different legal and commercial structures available depending on what the family wants to achieve.
The appropriate solution should be considered with legal and tax advisers rather than decided solely by reference to percentages.
Ideally, before there is a dispute.
Common opportunities to put an agreement in place or review an existing one include:
An agreement negotiated while family relationships are strong gives everyone an opportunity to discuss difficult scenarios objectively.
Trying to agree the same provisions after siblings or other family shareholders have fallen out can be considerably more difficult.
Every family-owned company should consider whether its shareholders can answer these questions:
1. Who is allowed to own shares in the business?
2. Can shares be transferred to spouses or other family members?
3. Does owning shares give a family member any entitlement to employment?
4. How are salaries and dividends determined?
5. Who makes the major business decisions?
6. What happens when a shareholder wants to retire or leave?
7. How will shares be valued on an exit?
8. What happens to a shareholder’s shares when they die?
9. How will ownership pass to the next generation?
10. What happens if family shareholders fundamentally disagree?
If the family does not have clear answers, it may be time to review its shareholder arrangements.
A successful family business can represent decades of work and a substantial part of a family’s wealth.
Protecting it requires more than trusting that future generations will always agree.
A well-drafted family business shareholders’ agreement can establish clear rules concerning ownership, management, succession, share transfers, valuation, dividends and dispute resolution.
More importantly, preparing the agreement forces the family to discuss difficult issues before they become actual problems.
The objective is not to remove trust from the family business.
It is to ensure that the business has a clear framework capable of surviving changes in both the company and the family.
Sherwin O’Riordan Solicitors advises family businesses, founders, directors and shareholders on shareholders’ agreements and shareholder disputes in Ireland.
We can advise on agreements dealing with family business succession, share transfers, pre-emption rights, reserved matters, shareholder exits, share valuation, death of a shareholder, 50/50 shareholder deadlock and dispute resolution.
We also advise where disputes have already arisen between family shareholders, including disagreements concerning control of the company, minority shareholder rights, share ownership and shareholder buyouts.
If you own a business with family members or are considering transferring shares to the next generation putting clear arrangements in place now can help protect both the company and the family relationships behind it.
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