This issue of our regular Family Office Newsletter takes us to Bremen, an old Hanseatic town where the tradition of family businesses is deeply rooted. The history of family businesses offers extensive experience with property transfers between generations and may inspire successful families in the Czech Republic and Slovakia.
This time, we have discussed succession with Rolf Mählmann, a Board member and the Head of Family Owned and Managed Businesses at RSM Deutschland.
The topic of asset transfers from parents to children is naturally new to central Europe. However, in Germany, succession has its rightful place, considering the strong tradition of family businesses. When successful families start dealing with the transfer of their wealth to their children?
Although asset transfers to descendants may be associated with a parent’s older age, in Germany, we pay attention to these issues from childhood. On the one hand, we are motivated by the tax regime governing inheritance taxes with significant new legislation in the past and, on the other hand, it is a big issue at a son/daughter’s wedding.
Which key facts should be considered when building the strategy?
In the first step, it is very important to understand the view, expectations and ideas of the older generation. This is crucial for developing an individual succession plan.
There are several crucial facts that need to be taken into account. Primarily, factors playing the key role are the decision to retire and the expected form of distributing the inheritance. Account must be taken of how the family functions and of the emotional closeness that has been built for many years. Making a radical change to them and not reflecting these relationships would indeed have disastrous effects on the family’s inheritance and functioning. In our consulting practice related to family guidance, succession is very often organised in several steps. This process can be planned over more than a decade. In the first step, the children become a shareholder of the family business holding a minority share. After a few years and proof of their work, the shareholding can be increased. In the final step, which is sometimes many years later, they acquire the remaining shareholding. In addition, the older generation very often retains significant voting rights for voting at the shareholders meeting.
Then, rather technical and legal factors come into play. This means that it is necessary to consider the method and functioning of the family business, make a realistic assessment of potential benefits of the descendants for the future of the business, and strategically plan their role in the business (which can even mean that they will be left out from active management of the assets). Account should also be taken of legal and tax aspects so that the process can be implemented as transparently and flawlessly as possible and could not be challenged in this respect. As a result, the process of developing a final succession plan can be quite time-consuming and sometimes takes 2 or 3 years.
You say that in Germany you start dealing with succession issues as early as at the wedding. Isn’t it a bit soon?
Asset transfers between generations should be considered with a cool head. One must understand that the wedding brings into the family an external factor – the spouse. However, the spouse does not come alone. It is also their relatives who join the family, with all the pluses and minuses. Therefore, a prenuptial agreement is the key to the family’s assets, as its objective is to protect the assets. It is also a safeguard against adverse external influences.
However, we should realise that the concept of prenuptial agreement has been around for many years and is considered a part of family life. It is nothing unexpected and everyone should understand its role – that is, not to restrict but to protect.
With larger families with a considerable amount of wealth, it proved useful to develop family governance. This includes the family’s fundamental philosophy, general ideas concerning succession and the technical issues of working together over generations.
And what about inheritance tax?
We have inheritance tax in Germany, of course. And this is also one of the factors that make families deal with succession sufficiently in advance. There is a rule that transfers of assets worth EUR 400,000 from parent to child are exempt from inheritance tax once in ten years.
Assets are redistributed at various levels and in various relationships.
Grandparents formulate their inheritance towards diverse generations within their family. Their own children obtain direct access to the source of the family’s wealth, shares are distributed and the method of disposing of the shares is defined.
Equally, grandparents may set up funds designated for their grandchildren. In the case of such funds, they make use of the German inheritance tax laws under which donations of up to EUR 200,000 made to grandchildren are exempt from inheritance tax. The donations are often designated for future education. The funds can be intended, for example, to finance their studies or assist them at the beginning of their independent lives.
However, in particular, the objective is to preserve the results of their lifetime’s work and the work of their ancestors for the benefit of the next generations.
Succession planning includes rules for asset transfers to the next generation as well as rules of how the future owners of the family assets will take care of their parents…
Of course, asset transfer involves the children’s obligation to care for their parents properly, provide them with adequate housing and income as well as, for instance, funding appropriate healthcare. At the same time, parents have several instruments for protecting themselves from any problem, such as keeping voting rights in the family business…We usually incorporate in the donation contract several fall-back rules that allow the donor to revoke the donation. This can apply to situations such as when the donee dies before the donor, becomes an addict or is sentenced to imprisonment.
Are the rules related to succession and distribution of assets strictly defined or do they change in time and adapt to life?
Each family develops and the rules of asset distribution and disposal must equally adapt to the circumstances. That is why succession organised in different steps makes sense in many circumstances.
Succession planning is indeed a complex issue. What else do families expect from their Family Office?
In my personal experience, the role of the Family Office starts in a position similar to a family’s financial adviser. First, its task is to take care of accounting and taxes. And gradually, as it wins the trust of the family, it becomes an adviser on investments, providing support with a suitable wealth structure including diverse asset classes, communicates with banks, gradually consolidates the family’s assets, and, in the end, it becomes the family’s financial manager.
This approach is traditionally appreciated by the head of the family. Mainly if it is a person not familiar with financial, investment and accounting issues, the services of such a “part-time CFO” are very welcome. The Family Office often takes responsibility for communicating with banks and represents the client in negotiations with the banks and is responsible for supervising the performance.
This all shows that the Family Office must be available. I usually meet with the heads of particular families once in a month.
Thank you for the interview.