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Tools for Effective Succession Planning for Family Businesses

The pandemic has hurt many families. There is no solace or succor for the lost loved ones. Yet as harsh as it may sound, life has to go on, for the rest of the family. This feeling of vulnerability has to be channelized to ensure that every entrepreneur, business owner, and head of business family think of securing themselves legally to ensure succession & estate planning.

It is way past the days when parampara (tradition) and prathistha (prestige) and prashasan (administration) were sufficient for a family to run its business. Since change is the only constant, the pandemic has forced many family businesses to re-consider and re-structure their succession and legacy planning as it has drastically increased the probability of unforeseeable deaths and long-term health complications of the family members. Demise of the family’s patriarch in the absence of a legitimate will, post-covid health complications rendering everyday functions and business operations redundant are some of the scenarios which are impairing the families resulting in stress, loss of business liquidity, and business opportunities.

Despite the abovementioned challenges and economic uncertainty statistics reveal a strong resilience for recovery. In the current financial year. 51% of family businesses are eyeing opportunities for growth in the domestic market, 22% shall be focusing on diversification, while 10% are contemplating entering the international markets[1]. However, it has also paved the way for drastic changes in the ways a family business shall operate.

Two areas that will be witnessing restructuring in the family business operations are; legacy planning and digitization. According to PWC’s 10th Global Family Business Survey, 2021[2] over 87% of family-run businesses have identified digital innovation and technology as the focal point of priority over the next two years. Succession planning is one of the most sensitive issues in family-run businesses. However, Covid 19 appears to have concentrated minds in this area. The survey confirmed that 20% of business families have incorporated a formal succession plan, while 7% of such families have revised their legacy plans in light of the pandemic.  

This piece intends to explore various tactics, legal resources, and preventive measures that are currently available at the disposal of family businesses to adopt a viable succession plan and lay down a comprehensive list of suggestions and actions that can be immediately incorporated and undertaken by such entities to this effect.

Dos and Don’ts of Succession Planning

 

While undertaking measures to establish a legacy plan, family harmony and communication are the two keys, which are imperative to be kept at the forefront. It is pertinent to ensure that succession planning does not prove to be detrimental to a family’s peace and unity.

The following two approaches should be incorporated while formulating a succession plan for a family business, in favor of the family’s interest:  

  • Family Harmony Comes First: Successful family business owners have believed that selflessly putting the family first is key to the survival of their business. Decisions that keep the family together should be given priority even if they could potentially cause short-term losses. Dynasties crumble due to family feuds and individual egos overpowering affection and mutual respect.
  • Communication is the Key: There needs to be clarity amongst all the family members, especially the next generation about their future roles. The older generation needs to have an open discussion with the young beneficiaries, about their exit and the subsequent taking over of the business after them. Similarly, the younger generation needs to communicate their plans for the future and expectations in advance so that a succession plan can be tailored in line with their mutual terms of agreements and prospects. It is advisable to engage an external facilitator who can assist the concerned parties to convert their aspirations, interests, and competencies and formulate a plan in the larger interest of the business. If the younger generation wants no part in the family business, then their decision should be respected otherwise a forced responsibility in the family business either through a Will or otherwise will only lead to resentment and strife in the family; and be violative of industry’s regulatory clauses depending upon the nature of business.
 
 

Planning for Protection of Assets in the Event of Succession

 

Most Indian family-owned businesses managed their assets and wealth themselves. Therefore, succession was either governed by will or personal laws. However, since succession and property laws are unique to every religion, the process became complex.

The indifference and ignorance of senior members of the family towards these issues is the primary cause for extensive litigation cases, mainly pertaining to title disputes. The following succession planning tools are recommended to sidestep from such scenarios:

  1. Will: Leaving behind a validly executed Will is the most uncomplicated mode through which a property can be passed down to the next owner. There is no fixed format for a Will under the law. The only requirements for a valid Will according to the Indian Succession Act, 1925 are; it should be made by a sound adult, signed by them, and attested by two witnesses. It is recommended that an Executor be appointed in the Will to reduce hassles. It is not compulsory to register a Will. Probate is also required only if the Will is made in Bengal, Bihar, Orissa, and Assam and within the local limits of the ordinary original civil jurisdiction of the High Courts of Madras and Bombay or where the property of the deceased is situated in these areas.

There are two scenarios that are to be considered while determining the ownership of a share in the family business after the death of a person:

  • In case a person dies leaving a Will: A person can make a bequest of his share in the family business by a Will according to the constitution of the family business:
    1. Corporate Structure: Large family businesses often operate through a private company structure in which the shares are issued to family members and the management positions are held by family members. Shares held by an individual family member can be willed by that person. A family company continues to operate after one’s death as it is a separate legal entity. The assets in the company belong to the Company alone and cannot form part of the estate and therefore cannot be transferred by a Will.
    2. Partnerships: Most small-scale family businesses in India work through the partnership model. The Partnership Deed between the family members as partners should ideally have a clause that provides for the procedure to be followed on the death of a partner. A family business owner can make a bequest of his share in the partnership in the Will, but the beneficiary does not become a partner to the firm unless all the partners of the firm consent to it.
    3. HUF: Many traditional family businesses do not have a formal document in place but may operate through a Hindu Undivided Family (HUF). According to Section 30 of the Hindu Succession Act, 1956, a person can make a testamentary disposition of his share in a co-parcenary property i.e he may dispose of his share in the assets of the family business (HUF) through a Will.
  • In case a person dies without leaving a Will: The ownership of the stake in the family business will be determined by intestate succession i.e succession according to the personal law of the deceased individual. The heirs will be determined in accordance with the religion of the intestate for example Hindus, Buddhists, Sikhs, and Jains will be governed by the Hindu Succession Act, 1956, Muslims will be governed by the Mohammedan Law and all others will be determined by the Indian Succession Act, 1925.
  1. Trusts: The Indian Trusts Act, 1882 governs the creation of a Private Trust. A trust may be created during the lifetime of a person, referred to as the author / s It may be created with a written legal document through which the assets of the settlor are placed into a trust and trustees are appointed therein who manage these assets for the benefit of the settlor and the beneficiaries named in the Trust Deed. The biggest advantage of Trust is that it operates both during and after a person’s life.
    • A written Trust Deed is signed by the Settlor, requires a minimum of two trustees and two witnesses. The trust may or not be registered; registration is required only if an immovable property is transferred to the trust.
    • Family wealth can be secured with the help of trusts. The manner of conducting business, areas of responsibility, and pre-empting scenarios can also form part of the trust constitution.
    • Another benefit of Trust as a planning option is its dependability during a crisis. It helps in ringfencing the assets from any action taken by creditors or banks in the event of a financial crisis.
    • When a settlor dies, the trustee pays the debts, files the tax returns, and distributes the assets of a deceased. Trusts are an effective estate-planning tool if one wants to avoid the costs and hassles involved in obtaining probate. It is a quick and quiet procedure, preserving one’s privacy and done without any court interference.
  1. Family Constitution/ Charter/ Framework: Business assets such as securities can be accounted for in a Will or a Trust, however, it is also necessary for a family business to plan for succession of management of the business. These are often covered in Family Constitutions or any other business manifests. It clearly lays out the interaction between the family and the business. It is a document that can be used for governing the administration of the family business. Apart from detailing the values and ethos of the family business, it may also specify rules like the incoming generation would need to get a master’s degree and, work outside to ensure they are well equipped when they join the business. It may also make provisions for events like death, marriage and divorce in the family. However, for any family members to succeed onto the Board of Directors or any other Key Managerial Position, resolutions by the existing Board of Directors and/or shareholders would be required. It is recommended that the younger generation (if adults) should be made aware of the Family Charter, allowed to participate and their opinions should be given due consideration so that the document is in line with the thoughts of the incoming members of the business. This helps in maintaining a balance between the old and the new.
  1. Family Arrangements: Family arrangement resolves present or possible future disputes among family members ensuring equitable distribution of property among the family members. In a Family arrangement, a member gives up all claims in respect of all the properties in dispute other than the ones falling to their share. The rights of all the others are recognized. Therefore, under a Family arrangement, members of a family may decide amongst themselves about the distribution of the property of the deceased. A Family arrangement would have to be appropriately stamped and registered. However, even oral arrangements are valid in the eyes of law.
  1. Clear Retirement Policies: While making a succession plan, there should be a provision for a clear retirement policy that includes defining the benefits and shareholding of the outgoing generation post-retirement.
  1. Guardianship: Where minor children are involved, it is very important to make provisions either in a Will or by Trust, for appointing a guardian for minor children in the event of a parent’s death. If one parent dies, then the other living parent likely becomes the guardian subject to personal laws. If both parents die, then it is needed to mention who will be accorded guardianship. Failure to do so will involve the intervention of courts and various applicable laws given India’s pluralistic society. The need for an appropriate guardian is not only to provide for personal needs but to also ensure that the share of minors in family businesses are protected during the period of minority.
  1. Conflict Resolution Forums: Family disputes are often dragged to courts and fought in public. Creating conflict resolution forums in the family constitution is recommended where family members can discuss their differences and resolve disputes amicably. These forums may consist of trusted family members or outsiders like family friends who can fairly resolve the dispute. In case the dispute continues, family members may resort to mediation or arbitration. Litigation should be used only as a last resort. To maintain peace in the family, a well-drawn-out conflict resolution forum is necessary. Resorting to legal recourse at the first opportunity creates hostility and breaks down family relations.
  1. Setting up of Family Offices: Keeping track of investments and family wealth as it grows can become an extremely cumbersome task. Family Offices rescue family businesses and high net worth individuals from such burdens along with managing the administrative issues that crop up daily. Family Offices handle investment portfolios, taxes, provide legal support, maintain documentation, and manage shared assets of the family businesses.
  1. Choosing a Successor: The family business will flourish only if a family member has the passion to take on the responsibilities to run the day-to-day business. It is, therefore, important to identify a successor who not only has the skill sets to be the leader but also has the drive and excitement to take the business forward. Forcing the responsibility of running the family business onto uninterested family members would be detrimental to the business as the stakes are high for all stakeholders. When deciding between family and non-family members to run the business, the family should objectively identify and evaluate a variety of candidates early on. Whether family or non-family, they should be given the requisite training and opportunities to grow, and the best candidate often emerges over time. If no family member is qualified and/or willing to take the position, then the current leader must make the tough decision to appoint an external candidate or professional for the role.
  1. Mentoring the Next Generation: An important factor for successful business transfer is mentoring of the next generation of leaders before and after they take over the family business. It would be fruitful to train and groom them so that they learn and understand the culture and values on which the business was built. Often, business owners are afraid to give up their central roles in the system and hand over the reins of the business to newcomers even if they are family members. Successful family business leaders have kept aside their egos and objectively help build the mindset of the prospective leaders. One way to groom the next generation is to give them challenging tasks and the autonomy to make their own decisions. The current generation can also create a management training program for the next generation joining the business, in consultation with key senior personnel. This gives them a flavour of various aspects and functions of the business.
  1. Tackling Issues of Nepotism: One of the biggest challenges in any family business is tackling nepotism allegations, especially by the younger generation. Nepotism is inevitably a part of the package deal that cannot be avoided. If an undeserving family member is given a senior position in the business, it may result in low morale amongst the employees. What can be done is, minimalize its effect on the non-family employees. A good way to tackle nepotism is to set out clear employment policies. What qualifications would be required for a certain position in the business and what is expected from a family member if they do take up that role? Giving them compensation based on their performance instead of their relationship within the family, preparing them thoroughly for a position, and giving them jobs that fit their skill sets are some of the best practices which can be adopted by family-run businesses.

Since change is the only constant, the pandemic has forced many family businesses to re-consider and re-structure their succession and legacy planning, as it has drastically increased the probability of unforeseeable deaths and long-term health complications. Demise of the family’s patriarch in the absence of a legitimate will, post-covid health complications rendering everyday functions and business operations redundant are some of the scenarios which are impairing the families resulting in stress, loss of business liquidity, and business opportunities. 

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Bad Bank in India: A Concept Note

The Indian banking system has been grappling with the ballooning Non-Performing Assets (NPAs) crisis on its balance sheets for decades now. The pandemic marked a further downward spiral for the Indian economy; proving specifically detrimental to individual borrowers and large corporates across sectors, who were adversely affected by the cash flow in businesses which led to defaults in outstanding obligations. The consequential increase in the NPAs revived the discussions for institutionalizing an independent entity that would exclusively deal with the bad loans and help in cleaning up the NPAs off the balance sheets. As of March 2021, the total NPAs in the banking system amounted to Rs 8.35 lakh crore (approx). According to the Reserve Bank of India’s (RBI) financial stability report, the gross NPAs ratio for the banking sector could rise to 9.8% by March 2022.

Following India’s first-ever Bad Bank announcement in the 2021-22 Union Budget by the Finance Minister; India, Debt Resolution Company Ltd (“IDRCL”), an Asset Management Company (“AMC”) has been set up that shall work in tandem with the National Asset Reconstruction Company Ltd (“NARCL”) to streamline and square away bad loans as per the documents and data available with the Registrar of Companies (“RoC”).

Proposed Mechanism of Bad Bank in India

  • The Government of India (“GOI”) has primarily set up two entities to acquire stressed assets from banks and then sell them in the market.
  • The NARCL has been incorporated under the Companies Act, 2013. NARCL will buy stressed assets worth INR 2 lakh crore from banks in phases and sell them to buyers of distressed debt. NARCL shall also be responsible for the valuation of bad loans to determine the price at which they will be sold. Public Sector Banks (PSBs) will jointly own 51% in NARCL.
  • The IDRCL will be an operational entity wherein 51% ownership will be of private-sector lenders / commercial banks, while the PSBs shall own a maximum of 49%.

NARCL will purchase bad loans from banks and shall pay 15% of the agreed price in cash, and the remaining 85% in the form of Security Receipts. If the bad loans remain unsold, the government guarantee shall be invoked; a provision worth INR 30,600 crore has been structured for the same.

Benefits of Bad Bank in India

Since non-performing assets have majorly impacted Public Sector Banks, the institutionalization of a Bad Bank shall equip PSBs in selling / transferring the NPAs, while simultaneously improving and promoting credit quality, strategically minimizing efforts in loan recovery and enhancing the macroeconomy.

Additionally, the profits of the banks were mostly utilized to cut losses. With the NPAs off their balance sheets, the banks will have more capital to lend to retail borrowers and large corporates.

The issues faced by Asset Reconstruction Companies (ARCs) relating to the governance, acceptance of deep discount on loans, and valuation may not concern the Bad Bank, owing to the government’s initiative and support that engages appropriate expertise.

 

Challenges of Bad Bank

As per the operational structure, bad banks shall buy bad loans, that have been recorded in the books of the PSB’s or private lenders. If the institution fails to secure buyers and record appropriate prices for the assets, the entire exercise shall prove to be futile.

In India, 75% of the bad loans are defaulted corporate loans, including a consortium of banks that had loaned corporations to finance major infrastructure and industrial projects. Countries such as Mexico, Greece, South Korea, Argentina, and Italy have portrayed that bad banks rarely yield positive outcomes in settings dominated by industrial, corporate, and conglomerate-level bad loans. Hence, structural and governance issues at various levels with state governments, judiciary, and political interests shall have to be streamlined and implemented efficiently to steer away from making them a repository of bad loans and for cleaning up the books of the PSBs.

Bad Bank: A One-Time Exercise?

The Government of India will have to undertake appropriate reforms/lending norms to reduce the number of NPAs. Setting up Bad Bank is most likely to tackle only the existing NPAs problem and should be a one-time exercise.

The concept of Bad Bank has been a success in certain European countries and the United States of America, however, it is pertinent to understand that they were structured to tackle home loans and toxic mortgages, unlike in India. Hence, in-depth analysis of the experiences of these countries should be utilized and intricately be revamped in alignment with key differences to ascertain the role of Bad Bank in the near future in the country.

Banks will get a huge financial boost with the transfer of the NPAs off their books and help in credit growth in the country. The success of Bad Bank is also crucial in restoring the faith of the taxpayer in the banking system. With the existence of the Insolvency and Bankruptcy Code, 2016 and Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, it remains to be seen how a Bad Bank will be a complement in the resolution of the bad loans.

 

Image Credits: Photo by Visual Stories || Micheile on Unsplash

The concept of Bad Bank has been a success in certain European countries and the United States of America, however, it is pertinent to understand that they were structured to tackle home loans and toxic mortgages, unlike in India. Hence, in-depth analysis of the experiences of these countries should be utilized and intricately be revamped in alignment with key differences to ascertain the role of Bad Bank in near future in the country.

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Being COVID Sanguine: Some Silver Linings to the Pandemic

Given the devastating effects the COVID 19 pandemic has had on the world in general and India in particular, you’re probably wondering about the title of this blog. Don’t get me wrong- I am in no way trying to diminish the massive damage to life, livelihoods and health that the pandemic has brought upon millions of people in India and around the world. Had I seen a similar title even 4 months ago, I too would probably have experienced thoughts similar to what you felt. 

So what has changed in a matter of a few weeks? There has been a major drop in the number of cases around the country; instances of serious infections requiring ICU care have also declined. The vaccination drive is going from strength to strength, with as many as 10 million people being vaccinated across India on a single day.

But the biggest change is in my own perspective. Earlier, I always saw only the negative and the bleak, but now I am beginning to see some positives. And that’s what prompted me to write this piece. Here are five specific areas in which I see positives.

Our people exhibited phenomenal resolve and resilience

The second wave (March-June 2021) was especially brutal on India. Our healthcare infrastructure was stretched beyond breaking point. Oxygen was in short supply, as were critical drugs. Medical experts were trying to firm up treatment protocols. Although vaccinations had begun for some people, the Cowin portal was glitchy and even vaccine supply chains were far from streamlined.

But we saw hundreds of self-help groups come up on platforms like Whatsapp and Telegram. Volunteers would man them 24×7 to ensure that across India, patients and their families got access to critical resources including food, oxygen cylinders and medicines. These supplemented (and often replaced) government measures. Technology was used to the fullest, to ensure that people knew where vaccine doses were available, so they could quickly register.

The pandemic has powered a surge of innovations

Almost every day, there were/are media reports around some innovative activity in India. Some emanate from the government sector: for example, in many cities, stadia and large school buildings were converted into makeshift hospitals or Covid Care Centres.

There are many examples of innovation emerging from private enterprise too. For example, given the large quantities of PPE waste being generated, someone came up with a way to convert used PPE kits (which would otherwise have to be incinerated or buried safely in landfills) into briquettes that can be used for constructing low-cost housing.

Around the country, different teams developed prototypes of low-cost oxygenators and ventilators. This will be a source of great benefit to the country because it reduces dependence on imports. And as we have seen, geopolitical triggers or maritime issues (like the ship getting stuck in the Suez Canal) can wreak havoc with global supplies.

Recently, I read about a woman-led team in Hyderabad inventing a fabric that has anti-virus and anti-bacterial properties. Imagine the wide range of applications at home, in workplaces and public spaces for such a versatile invention.

 

Public-Private Partnership (PPP) redefined

The notion of Public-Private Partnerships too has changed in the last 18 months or so. Whether this is a direct result of the pandemic or more the outcome of policy changes is perhaps hard to separate. But India as a nation is seeing much higher levels of collaboration between government laboratories and infrastructure and the private sector. DRDO collaborating with start-ups for developing drones that can be used for vaccine delivery is one example. Another is ISRO encouraging startups and even students to design satellites. A third is ICMR collaborating with Bharat Biotec in the development of Covaxin, India’s first indigenous Covid vaccine.

Passions are changing into professions, creating employment opportunities

On the one hand, the pandemic has killed many livelihoods. But with many people looking at new, home-based business ventures- and using digital channels to market themselves and deliver their products (and in some cases, services too), one can hope that they will be able to scale and over time, some job losses can be offset. Examples include food delivery, baking, making pickles etc.  Of course, India still needs contact-based industries, such as construction and manufacturing, to pick up and get back on track.

Attempts to harness the creative talent of our youth

This may not be directly linked to the pandemic, but I believe that greater participation will result because of the restrictions imposed by it. The government is looking for innovative ideas from our youth. The Bureau of Police Research and Development (BPR&D) and The All India Council for Technical Education (AICTE) recently announced Manthan 21, a “hackathon” aimed at getting our country’s youth to come up with innovative solutions to address the challenges faced by our intelligence and security agencies. Specific areas have been identified. (more details are available here: https://manthan.mic.gov.in/about-intellithon.php).

 

Experts say that the world around us has changed for ever, and there’s a “new normal” in the wake of the pandemic. There is no doubt about that. But hybrid working models or other changes visible in the organized sector (especially in larger firms and companies) are not the only changes to our world resulting from the pandemic. The impact of the less visible changes described above too will be felt by India and the world in the years ahead.

 

The second wave (March-June 2021) was especially brutal on India. But we saw hundreds of self-help groups come up on platforms like Whatsapp and Telegram. Volunteers would man them 24×7 to ensure that across India, patients and their families got access to critical resources including food, oxygen cylinders and medicines. 

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Income Tax Relief for Developers and Residential Home Buyers To Boost Real Estate Sector

In a bid to provide an additional boost to the economy, as well as the home buyers, the Union Finance Minister – Nirmala Sitharaman, has announced a new stimulus package under Atma Nirbhar Bharat 3.0, on November 12, 2020.  As per the announcement, the acceptable difference between the ‘circle rate’ and the ‘agreement value’ for residential properties has been hiked from the existing 10% to 20%. The tax sop announced is expected to provide relief both to Developers as well as to Buyers, on the notional gains on which income tax is paid by them. The relief, which has been made effective from November 12, 2020, and will be applicable until June 30, 2021, is applicable only on the primary purchase of residential unit of value up to Rs. 2 crores.

What is Circle Rate?

 

Circle rate is the minimum rate per square foot for land or property fixed by the Government. State governments publish area-wise rates of properties, on a yearly basis, known as ‘Circle Rates’ or ‘Ready Reckoner’ rates or ‘Guideline Values’. Any difference between the Circle rate and the Agreement value beyond the acceptable rate [i.e. 10%, now increased to 20%], is taxed as “income from other sources” u/s. 56(2)(x) of the Income-tax Act 1961 (“the Act”). Accordingly, a Buyer of such property would be required to pay tax on the difference, at the applicable slab rates. Further, in the case of a Developer, under the provisions of section 43CA of the Act, the ‘sale consideration’ of such a property is deemed to be the Circle rate for the purposes of computing profits & gains.

 

 

How this will benefit?

Assume that a Buyer is buying a residential property from a Developer for a sum of Rs. 1 crore. The Circle rate value of the property is Rs. 1.2 crore. Prior to the relaxation, as the difference between the Circle rate value and Agreement value exceeded 10%, the Developer was required to consider Rs. 1.2 crore as his Sale consideration u/s. 43CA of the Act for the purpose of calculating his Profit & Gains from Business & Profession.

 

Similarly, since the difference between the Circle rate value and Agreement value exceeded 10%, the Buyer was required to show the difference between the Circle rate value and Sale consideration of Rs. 20 lacs (1.2 crore Less 1 crore) as deemed income under the head “Income from other sources” u/s. 56(2)(x) of the Act and pay tax on the same at the applicable rate.

 

The stimulus package announced provides relief by increasing the acceptable difference between the Circle rate and Agreement value from 10 % to 20 %, providing much-needed relief, both to the Buyer as well as to the Developer, during the current pandemic times.

 

The above tax sop is available only on purchase of new residential property from the Developer of value up to Rs. 2 crores and is not applicable on the resale of property. Also, the said benefit is not extended to the sale of commercial property. Nevertheless, the stimulus is expected to help Developers to clear unsold stock and generate liquidity for their other projects.

Image Credits: Nataliya Vaitkevich from Pexels

The stimulus package announced provides relief by increasing the acceptable difference between the Circle rate and Agreement value from 10 % to 20 %, providing much-needed relief, both to the Buyer as well as to the Developer, during the current pandemic times.

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