The Family Business: Succession and Stewardship Estate Planning Considerations for Transitioning the Family Business into the Hands of the Next Generation

The Family Business: Succession and Stewardship Estate Planning Considerations for Transitioning the Family Business into the Hands of the Next Generation

About Jane CollisJane Collis

Jane Collis is a member of the property and private client practice group, specializing in estate planning, wills, international and domestic trusts and probate.

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Bermuda has many resourceful and hard-working business proprietors. Each one loves the enterprise he or she has built and for many, the hope is that it will continue many years and possibly many generations into the future. The successful continuation of the business after the death of the proprietor is not, however, a foregone conclusion and if this is a paramount goal of the proprietor, estate planning will be required.

The specific issues that arise in the context of succession to a family business will depend, in the first instance, on the form of that business. Different considerations arise in the context of a sole proprietorship than a limited liability company or partnership, but regardless of the form of business, it is essential to address the future. This article will deal solely with sole proprietorships and I will consider issues related to succession in the context of a limited liability company at a later time.

Sole proprietorship

More than any other form of business, the sole proprietorship (the unincorporated business) requires the proprietor to focus on his or her vision for the future and to spell out the specifics in a Last Will and Testament (a “Will”). The general rule is that in the absence of express direction in a Will, personal representatives will have only limited authority to carry on a deceased proprietor’s business to preserve its value for sale. The relevant period at their disposal for these purposes is generally taken as amounting to the “executor’s year” (one year from the proprietor’s date of death). As to what constitutes sufficient direction, case law has established a requirement for “distinct and positive authority”, but if a Will contains a power to postpone the sale of estate assets, this may be taken as adequate authorisation, at least, to keep the business operating beyond the executor’s year.

In considering the terms of his or her Will a proprietor should be prepared to address the following specific issues, as a lack of clarity may lead to uncertainty for the estate executors and possible family conflict.

  1. Exactly what are the assets of the business?

Technically, the assets of a sole proprietorship may include stock in trade, plant and equipment, vehicles, machinery, freehold and leasehold premises used by and for the business, receivables, cash and goodwill. However, as title to these assets is usually registered in the name of the business proprietor (the business having no separate legal personality), in the absence of express direction by Will, it may not be immediately apparent which assets the proprietor intended to form part of the business and which to form part of his or her residuary estate. This is particularly relevant with respect to business premises and vehicles, but also with respect to capital. A general direction to carry on a business would not, for example, be sufficient to allow the personal representatives to invest capital in the business that was part of the proprietor’s personal estate.

  1. What are the mechanics of the gift of a business?

The gift of a sole proprietorship by Will has the effect of passing all of the assets and liabilities of the business to the executors, until the estate is administered. Thus, any contracts that were entered into by the proprietor before his or her death must be completed by the personal representatives. Any trade creditors will stand in priority to the beneficiaries of the estate, though not in priority to estate creditors, which means the business debts must be settled after the estate debts, but before the beneficiaries receive a distribution.  Dealing with business liabilities can be a daunting prospect for personal representatives. Valuing the business may also present difficulties, particularly where it is not immediately clear which assets in the estate are strictly business assets and which were used by the proprietor personally as well as for business purposes. The latter can give rise to family disagreement if a gift of the business is made to one beneficiary and the treatment of particular assets as business assets will reduce the value of the gifts passing to other beneficiaries of the estate.

  1. Who would be suitable executors?

In the case of a sole proprietor who dies intestate (without a Will), his or her personal representatives will be relatives, who may or may not be involved in running the business. If they are not involved, dealing with differentiating the assets and liabilities of the business from those of the estate and dealing with the liabilities of the business will be a potentially unnerving experience. It is highly unlikely that they will have the intestinal fortitude to keep the business going and even if they are willing, their powers will be limited. Any business proprietor for whom continuity is important cannot afford to die intestate. It really is that simple.

For the proprietor who plans ahead and is making decisions about the terms of his or her Will, consideration should be given to whether the nature of the business would recommend the appointment of special executors. Special executors are essentially a separate set of executors whose sole responsibility is dealing with the business and who do not become involved in other aspects of the administration of the proprietor’s estate. Businesses that are highly technical, fast-moving or that employ a number of people might fall into this category. Alternatively, it may be enough to select executors who will handle the entirety of the estate, but have some specialised business experience, making it easier for them to deal with necessary business decisions. The choice will depend on the nature and complexity of the business.

  1. What does “distinct and positive authority” look like?

Ideally, the executors, whether they be special executors or general executors, will be specifically authorised and directed to carry on the business either as a going concern, or for such time as may be necessary to find a buyer, whichever is the preference of the proprietor. Specific powers drafted into a Will might include, for example, powers to incorporate the business, to appoint managers and delegate responsibilities, to engage employees, to advance capital from the estate to the business, or to deal with real estate comprised in the estate for the purposes of the business. Once again, the nature and complexity of the business will largely dictate what powers should best be included in the Will.

Personal representatives faced with the decision as to whether or not to carry on a business without specific authorisation, or, at the very least, without a power to postpone sale given by the terms of the Will (which, will, of course, mean all personal representatives in the case of an intestate proprietor, who does not have a Will) must understand the risk. Most importantly, they will be held personally liable for all trade debts incurred from the date of the proprietor’s death. While it may seem reasonable for personal representatives to suspend all business activity to avoid such exposure, the urgency and pressure of keeping a business afloat and contracts fulfilled may make it almost impossible to avoid incurring trade debts. For any personal representatives facing this conflicted scenario, there are really only two options. In the case of an estate in which all of the beneficiaries are of age and capacity and wish the business to continue, the personal representatives may seek their written consent and an indemnity. If there are minor or incapacitated beneficiaries, the only alternative will be an application seeking the directions of the court, a costly and time-consuming effort.

  1. To whom should the business be given?

This can be a tougher decision than one might initially think. Many sole proprietors are very much alone in the enterprise, but still harbour dreams of the business as a family legacy. For others, there may be an obvious choice, a spouse or child who is intimately involved in the running of the business and shares the proprietor’s vision and commitment. Matters become more complicated where there are a number of children in the family, only some of whom are involved in day-to-day business operations.

A proprietor may struggle with balancing what is in the best interests of the business and what will be expected by the family. If it is clear on the face of it that the long-term viability of the business rests with the consolidation of ownership in the hands of a single family member, so be it. While there may be some fallout in the context of family dynamics, other family members can benefit from estate assets not connected to the business. Thus, for example, there could be immediate equalisation of benefit through distributions of real estate, cash or investments comprised in the estate, or structured payments of capital over time, to those beneficiaries who do not receive an interest in the business. There is no doubt that the business is more likely to survive and thrive in the hands of dedicated steward.

If incorporation is contemplated as a viable future for the business, then this would be a sensible direction to include in the Will as a means of navigating the rocky shore of family expectations. The personal representatives will remain in control and subject to fiduciary duties in relation to the newly formed company, but once administration of the estate has been completed, the shares of the company can be distributed to the beneficiaries. If desirable, control can be separated from benefit through the issue of different classes of shares, so some family members can manage the business, while others only receive income, ensuring a greater prospect of business viability and better family relationships.

In closing, it is worth making the point that a business proprietor should not only consider the future of the business in the context of his or her Will, but also in the context of a possible future loss of mental or physical capacity. It is advisable for any proprietor to execute an enduring power of attorney appointing capable persons to step in to business operations in the event of his or her loss of capacity. It is critical to the success of the business to ensure that decisions continue to be made even if the owner is unable to make them personally.